Each time there’s a market bubble, investors are worried about what could go wrong. The worst part is that this condition is usually unpredictable, leaving everyone powerless to secure their investments. Most of these people would rely on certain indicators that show when most likely the bubble happens.
Yet, for the large majority, it is not enough to look at the facts. There seems to be a need to adapt to this nature of the financial industry and create strategies that could respond to whatever the market brings. Whether it’s good or bad, some things are simply beyond control.
But here’s the catch: when you learn the fundamentals about the market bubble – its causes and phases, among others – you are in a better position to deal with it. You can easily devise an approach to protect your funds and also make some profits despite unfavorable market conditions.
There might also be opportunities that this situation can offer, and only those with a keen understanding can broadly spot them. This ability is best learned from the industry experts whom you may interact with on social trading platforms. Those who became millionaires by investing in cryptocurrency can also teach you lessons and encourage constant growth in the evolving world of this asset.
Understanding Market Bubble
The market bubble is a situation where the price of a financial asset exceeds its fundamental value by a large margin. This is usually fueled by speculative demand rather than intrinsic worth and can cause a massive decline in prices. On certain occasions, this phenomenon may result in a market crash and affect investors, in general. The consequences of a bubble are wide-ranging among players in the given industry.
A financial bubble is characterized by a fast and substantial climb in the market price of various assets. This rapid growth can be short-lived, suddenly change course, and drag asset prices down, which may be lower than the original levels. Many investors are caught up in a market bubble when they fail to analyze the direction of the market. This is where a thorough understanding of the fundamentals is quite important because only with the knowledge investors can secure their assets, no matter the market condition.
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Major Causes of Market Bubble
There are several events that can trigger a market bubble. It is clever for an investor to study all these things because they can be used as a reference to predict the price movements of their assets.
- New products increase the demand, and the price of an asset follows
- Assets are in shortage which causes their cost to climb
- Low-interest rates and other economic conditions encourage an influx of investments
- Interest rates encourage borrowing for spending, investment, and expansion
Another problem arises when an asset bubble begins, and some investors are plunging in, causing the prices to constantly rise. This behavior is caused by various motivations, such as herd mentality, short-term thinking, and cognitive dissonance.
What Happens During a Market Bubble?
When an asset bubble bursts, there are many things that could happen. Sometimes the impact is small, causing losses to a few investors. But on other occasions, it can trigger a market crash, economic recession, or depression. These consequences are dependent on the size of the bubble and what assets are involved. One research revealed that when there are debts involved in the bubble, the more damaging it is. Debt-fueled bubbles can cause longer-lived recessions.
Five Stages of a Market Bubble
Market bubbles don’t happen at once without certain indicators. Smart investors have the habit of analyzing the stages where the bubble manifests itself. Generally, they include the following:
At this stage, investors get enamored by a new paradigm, such as lower interest rates or innovative technology. Sometime in the year 2000, there was a displacement in the federal funds that lasted until 2003. Over this period, the interest rate on some mortgages dropped by 2.5%, resulting in a market bubble.
Following a displacement, the prices of an asset may rise slowly and eventually gain momentum as more participants enter the market. This can logically set the stage for the boom phase, where the asset can attract widespread media coverage. The fear of missing out on the promising opportunity can spur speculation, drawing an increasing number of investors and traders into the platform.
Investors may become euphoric and don’t mind any risks at all. This is what this phase is all about, and it’s characterized by the skyrocketing asset prices that fuel the desires of participants. They can observe extreme levels of valuation as new measures and metrics are touted to justify the relentless rise. There are many buyers who are willing to pay more as their interest heightens.
During this phase, there are warning signals that the bubble is about to burst in the market. Thus, investors are encouraged to sell their positions and take profits. The challenging part, however, is estimating the exact time when a bubble is due to happen because the market can stay irrational longer.
As experts say, once the bubble is pricked, even with a relatively minor event, it cannot inflate again. During this panic stage, the asset prices can reverse course and descend as rapidly as they had descended. Those investors who are confronting margin calls and decreasing values of their holdings may want to liquidate at any price. As the supply overwhelms the demand, the asset prices can slide sharply.
Market bubbles may be inevitable at times, and the best way to deal with them is to learn their causes, stages, and impact. Once you’re fully aware of the fundamentals, you can navigate better in the highly unpredictable market. The crypto industry is not exempt from this market condition, so you might as well take the time to do enough research before putting in your money. At the very least, you are in control of how you conduct business with other traders around the world. Keep in mind that a market bubble is also an opportunity to develop your skills as an investor.