What is a Bubble?
The stock market bubble is a kind of economic bubble that takes place in the stock market when the investors drive the stock prices above their actual valuation. A company’s actual value is determined by its business fundamentals like its profit, ability to grow in recessionary environments, and other different metrics.
When someone talks about a stock market bubble, they refer to the stock prices being inflated. The dot-com bubble of 1990’s is one of the most famous examples of a stock market bubble. Tech stocks shot up, fueled by high expectations for the new internet economy. When expectations were not fulfilled, nearly all of the tech stocks that had gained value during the boom years took a dive down. Bubbles can occur to any kind of assets like stocks, real estate, commodities, and cryptocurrencies.
What causes an Asset Bubble?
The initial stages of a bubble may be firm or gentle. For example, a market analyst might upgrade the recommendation of a stock, and that catches the attention of the investors who then become more bullish. Similarly, rumors, news reports, or information shared on social media could also spark a bullish trend.
What happens when a stock market bubble bursts?
All kinds of bubbles eventually burst, meaning that asset prices or trends can suddenly and sharply decline. An asset bubble pops whenever there’s a drastic change in expectations. For example, a bubble could burst as a result of selling activity that makes investors nervous, causing a panic selling and a further price decline.
The reason that led to the bursting of the dot-com bubble is slightly complicated. The tech companies’ performances didn’t match the investor’s expectations. Many dot-com names that went bankrupt had a really flawed model of business which made them incapable of making a profit. The dot-com companies’ growth eventually slowed, profits didn’t happen, and the tech prices plunged.
How to Invest During Stock Market Bubble?
There are 2 different kinds of investments that one can make during a bubbling market. First is the short-term play, and the second is the type of stock you can hold on to for a long time, even after the bubble bursts.
Another way to secure your portfolio during a market bubble is to buy put options, which enables you to sell the stock at a pre-determined price within a fixed period. One can also use stop-loss orders, which will automatically sell a stock once its price declines to a particular value. The only disadvantages of these alternatives are that buying put options can be expensive, and stop-loss orders might get executed even during a modest market pullback.