What is a Stock Market Bubble?
A stock market bubble is a rapid increase in the price of stocks on the stock market beyond what the intrinsic value of these stocks should be. This is often fueled by people’s excitement and herd mentality buying the same stocks, thus inflating the price of stocks. Eventually, the price becomes unsustainable and it bursts, resulting in a major stock market crash. Due to its high volatility, people often try to identify a stock market bubble to avoid it, or at least to be prepared when it bursts.
Sure-Fire Signs of a Stock Market Bubble
Identifying a stock market bubble can be a tricky task and it may take knowledgeable professionals to accurately identify one. Nevertheless, several signs can indicate a potential bubble and here are sure-fire signs to be on the lookout for:
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Unsustainable Price Increase: One of the clearest signs of a potential bubble is an unsustainable rise in stock prices. This is especially true when there is no obvious fundamental reason for the increase.
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Out-of-Control Speculation: Another major sign of a stock market bubble is speculation that has gotten out of control. People are trading stocks on rumors and hunches instead of grounding their investment decisions in reality and taking into account company fundamentals.
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Too Much Leverage: Leverage is when you borrow money or buy stocks on margin to increase the level of your investments. When the amount of debt taken on by traders increases, it is often a sign that a potential bubble may be forming. This is because the high borrowing leads to a flood of money into the stock market and it artificially inflates stock prices.
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Unusually High Volume: High trading volumes often indicate that something is going on in the stock market. Investors should watch out for unusually high volumes as it could indicate that something is brewing and something is happening in the stock market.
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Popular and Overpriced Stocks: When investors start buying certain stocks in an awkwardly high volume and if the stock outperforms the market significantly and prices get too high, it could be another indicator of a bubble forming.
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Reduced or No Volatility: High stock market volatility is a sign of a healthy market. However, if volatility drops and movements become predictable, it could be a sign of a bubble forming and it might be time to sell all assets with caution.
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Declining Fundamentals: Another sure-fire sign of a potential bubble forming is a sharp decline in the fundamental health of a company’s operations. This is a sign that people are buying stocks, despite deteriorating fundamentals or worse, they are unaware of them.
Identifying an impending stock market bubble can be difficult and it often requires the help of professionals and an understanding of the stock market. While there is no guarantee that a bubble is forming even if these signs are present, they are still sure-fire signs to be aware of and watch out for. Investors should know when to get out, and when to take the plunge; and good financial advice should always be taken into consideration. To be able to identify a stock market bubble and to make their investments successful all comes down to careful and detailed analysis.
