A beginner's guide to market bubbles

A bubble is when an asset, economy or market has a huge price spike, exceeding what is


considered to be its fundamental value by a


huge margin. Bubbles are sometimes identified retrospectively, often after


there was a crash of the cost of


the economy, market or asset in query.







The damage caused


by the burst of the bubble is dependent upon


the economic sector or sectors concerned: the


bursting of the US housing bubble in 2008 caused a world


financial crisis, because most banks and fiscal


establishments in America and Europe held many billions


of dollars worth of subprime mortgage-backed securities.

The 5 steps of a bubble

 Economic guru Hyman P Minsky identified 5 stages in a


credit cycle: displacement, boom, euphoria, profit taking and panic and this


general pattern is fairly consistent across bubbles in


varied sectors.

Stage 1 Displacement

 Displacement


happens when investors become


enthused


with something new: state-of-the-art technology in the


dot-com bubble, tulips in tulip mania ( a bubble in the 17th century where the


popularity of tulips climbed so


swiftly that tulips started selling for over ten times


the yearly salary of talented


craftsmen. Within months of the bubble bursting, tulips were selling


for One / Hundredth of their top prices ), or traditionally


low interest rates, as in the USA in June 2003, which started the


increase to the 2008 housing bubble.

Stage Two Boom

 Following a


displacement, prices start


climbing slowly. They gain momentum as more


traders enter the market, causing the


asset to draw in far-reaching coverage, then panic buying, which forces prices to record highs.

Stage Three Euphoria

 Prices


skyrocket: in the 1989 real-estate bubble in Japan, land


in Tokyo sold for up to USD139,000 per square foot. At


the peak of the web bubble in March Two


thousand, the mixed value of the technology stocks on the Naz was larger


than the GDP of most states.

 During the euphoric


phase, new valuation measures are promoted to justify the


spike in prices.

Stage Four Profit taking

 By this time,


talented traders start selling their positions and taking profits


sensing the bubble is going to burst. Nevertheless


determining the moment of collapse can be complicated and, if you miss it, you've most probably missed your opportunity to take


profits for good.

Stage Five Panic

 At that point, prices fall as speedily as


they originally rose. Traders faced with margin calls and the falling values of


their assets start panic selling: running from their


investments at any price. Supply soon overwhelms demand, and


prices plunge.

 In the 1989 Japanese


real estate bubble, real estate


lost nearly Eighty percent of its inflated


value, while stock prices fell by Seventy pc. Similarly, in October 2008, following the


collapse of Lehman Brothers, and the almost-collapse of


Fannie Mae, Freddie Mac and AIG, the SP 500 plunged nearly


17% in that month. That month, world equity markets lost


USD9.3 trillion, or 22% for their mixed market capitalisation.

Conclusion

 Being familiar with the stages of a bubble, whether it's in


the stock, forex, commodities or bonds


market, may help you identify


the subsequent one, and getting out before your profits


vanish.      









Remember that CFDs and forex are geared products and may lead to losses that surpass your first deposit. CFD trading might not be suitable for everyone, so please make sure you understand the risks involved.