A combination of forces, such as rapidly rising stock prices, market confidence that companies have great potential for future earnings, individual speculation around every corner, and widely available investment capital create an environment that inflates prices. share prices and gives rise to a situation called the stock market bubble.
The most common question that arises in our minds when we talk about bubbles is what actually causes the bubbles to form and then what causes them to pop again. Interestingly, it has been observed that greed and greed alone causes bubbles and then fear allows them to burst. We are all aware that the stock market is efficiently governed or controlled by greed and fear.
A bubble will form without causing much rippling due to the influence of what is known as the herd effect. When a hype starts in the stock market, everyone finds out about the new stocks on the market and tries to buy as much as they can. We sit back and enjoy as profits skyrocket with skyrocketing prices. So we get more and more greedy and we wait and watch, but we forget to sell.
Even stock market gurus and media-dominant analysts are adding to the hype and releasing their latest stock picks in a modern fashion. They show the positive side of the picture with the help of complex research analysis, eye-catching charts, and attractive graphics. But what they don’t do is remind people to sell and take home the profit. Therefore, it takes time for the news of the sale to reach the rumor mill.
However, by that time, the big investors or the so-called smart money segment will have sold the shares and cashed in some of those unrealized gains on paper alone. So the peak is reached as everyone is in and now the rapid recession begins as panic selling begins and stock prices fall. This is exactly when the stock market bubble is said to have burst.
Small and large investors who buy and hold every day get frustrated and walk away from the stock market. They walk away from the stock market determined to wait until the psychology of the market has regained its composition or never return. But the illusions of euphoria, the pleasures of taking home high returns, are too alluring to ignore the stock market for long. So they come back and hope similar to the time of the previous bubble formation and repeat the mistake of investing when the market goes back up and thus contributes to the next bubble.
During bubble times, you must maintain higher cash reserves than you normally do. To profit from a bubble situation, you have to be careful and smart. You should invest only in those stocks that are not overvalued. It’s easy to know when you’re in a bubble situation, but it’s hard to time the burst. Bubbles can take a long time to burst, and if it lasts too long, continued inflation can lead to serious losses. Bubble investing is certainly different from bull market investing. Play it safe and put only a fraction of your money into the bubble game.
There are several examples of large stock bubbles that continue to intrigue economists around the world. To highlight some exceptional bubbles, we must cite examples such as the tech bubble or dot com that peaked in 2000, the oil bubble that peaked in July 2008 when oil prices skyrocketed to $147 per barrel and then the housing bubble that burst 2007-2008.
However, instead of playing too cautiously or being too cautious with these bubbles, one should take some unprecedented and calculated risks and try to get something out of the bubble situation.