What is the Stock Market Bubble?

Even if you are not active in the financial markets, you have probably heard the word bubble many times and you are familiar with terms such as: “the price of a certain material is a bubble”, and “we have to wait for the bubble to burst and then buy”, and “sell a certain material now, the price is a bubble, you will make a profit” and dozens of other examples. Of course, the term bubble is much broader and is not limited to the stock market.


This term is widely used in markets such as currency, housing, and gold, and this frequency has caused many errors and changes in the exact and true meaning of the term bubble. In this article, we are going to talk about the correct concept of bubble and analyze it as accurately as possible, to analyze concepts such as bubble in the economy, the reason for their appearance, and how it works, to provide detailed explanations.


What is an economic bubble?

In short, when the price of a commodity in transactions is much higher than its intrinsic value, we say that the price of that commodity has a bubble. Some people interpret every price increase as a bubble, but as we said in the definition, the conditions must first be checked to see if the intrinsic value of that product has also increased if there has been no change; Or what are the inflation situation and similar questions. After the analysis, we can conclude whether the price of the product in question has a bubble or not.

Do the bubbles have a similar pattern?

Most bubbles have the same trend. According to the Dow theory, prominent trends usually consist of three distinct parts, and bubbles are no exception.


Condensation stage:

In the first stage of the formation of the bubble process, investors who usually have informational rent or are somehow optimistic about the price rise, enter the market and raise the price of goods to some extent with their powerful purchase.


Stage of public awareness or participation:

At this stage, after finding buying signals, analysts and active people enter the market, and as a result, the speed of this upward trend will increase and the price growth will increase significantly.


Distribution stage:

The stage of distribution or distribution usually happens when the price of the commodity or the stock has reached its peak and there is no more desire to grow. The distribution phase is a trap for people who are in a hurry and beginners because due to the news of the very good upward trend of these stocks in social networks and news, these people enter this trend.


Usually, during the third stage, the people who entered in stages one and two, liquidate their shares and leave the process. After this incident, due to the fear created among the shareholders and the increase in selling pressure, the share price returns a significant amount of its upward trend with a very fast and sharp movement. Usually, the chart of that stock experiences a free fall, this stage is also called the stage of emptying the bubble or bursting the bubble.


So, if we want to summarize the above, all the bubbles are formed at a high speed and burst at a higher speed and in less time and return to their original and original price. If the prices were stabilized and their prices did not decrease, it can be concluded that the created trend was not a bubble at all and the inherent price of stocks or goods has grown.

Among the most famous global market bubbles, we can mention the American stock market around 1930, China in 2006, and Saudi Arabia in 2005.


What are the causes of bubbles?

The emergence of a bubble can have wide and various reasons, for example, the increase in people’s liquidity causes an increase in demand, and if the market is not able to supply it in proportion, the lack of that product will cause a bubble and increase the price. Experts in economic fields consider the most important cause of the bubble to be Herding Behavior, which means that people tend to do that work simply because many people are doing it, and most do not have any knowledge and knowledge about the work in question.

This theory expresses the same trend pattern, for example, if shareholders see that many people are buying x shares, they are encouraged to buy x shares, and this cycle continues until the bubble bursts. This type of bubble is also called an irrational bubble.


Another reason for the emergence of bubbles is that people buy goods or stocks that they have a good view of its future, to sell to other people at a better price. The next people will repeat the same thing and continue this cycle as long as possible. When there are no more buyers for that stock or commodity, the bubble bursts, and the price falls. This type of bubble is also called a rational bubble.


What is the cause of the bubble in the stock market?

The main reason for the existence of bubbles in some shares is herd behavior. In this way, sometimes companies use the media to make their names known. By buying shares of that company, some people start a false and unreasonable process for the price of that share, and because there are enough buyers for this share, its price increases day by day. There is no fundamental reason for the price growth, just in line with the supply and demand, the stock price grows and this process causes a bubble to appear.


Finally, when the buyer finishes at a higher price, the pressure to sell the stock increases, and with the formation of consecutive sales queues, the stock price drops sharply and the bubble bursts until the real price or its intrinsic value is determined.

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