If you have been investing in the stock market, you would surely have heard of the term stock market bubble. That is one of the situations that investors would not like because of its uncertainties and unpredictability.
What actually happens?
As bleak as it might sound, this does not mean you are sure to lose your money during a stock market bubble. To know how it works and to get through it, it is essential to first understand what it is. In the share market, a bubble will occur when the price goes up rapidly until it breaches its actual value and then drops suddenly. It is not really any rocket science why it is called a bubble (and bursting). The 2007-1020 mortgage crisis in the US is one of the most evident examples of a stock market bubble.
Knowing when it happens
One of the hardest challenges market analysts face is in trying to predict a stock market bubble. There has been a lot of models and methods to do this but determining the actual price of an asset has always been difficult and even if it is a bubble, investors are still buying shares. Hence, it is somewhat difficult to control as well. That is why bubbles are always identified after they have occurred (which becomes counterproductive).
So, how do we know if we are in a bubble?
Make no mistake about this, it does not mean that a bubble occurs every time there is a sharp drop in prices. At times, it is just the market pressure corrective itself that can be very common. However, you can take note of certain signs like
- Suddenly it is extremely easy to buy certain assets that were difficult in the past
- News and speculation of price increase of certain asset surfaces frequently
While those signs are not confirmed that you are heading to a bubble, you can take precautionary steps.
- Go with the flow – This is not the best way to get out of the bubble but it could work to your favour. Obviously, this is for the more experienced traders because it means the bubble could burst at any unforeseen moment. You need to time the market and take the risk but if you get out unscatched, you could be very profitable.
- Wait it out – The other alternative is to wait for the bubble to burst. What you get out of this is that after the burst, stocks will be undervalued and that would be a good time to buy.
One thing for sure, the markets will recover after a stock market bubble bursts. There is no reason to panic and sell everything when it happens. Maintain your investment strategy and do your research before you enter again.
