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Economic Bubble - What Causes It And How Does It Impact Investments

Let’s take a deeper look at economic bubbles and their impact on investments and the stock market today

Monday June 27, 2022 3:34 PM, ummid.com News Network

Economic Bubble

Most people would agree that tulip flowers are beautiful. They come in a variety of stunning designs and are important in many cultures. But what if we tell you that, at one point in history, they were sold for prices as high as $50,000 just to plummet three years later?

This is exactly what happens in an economic bubble. Let’s take a deeper look at economic bubbles and their impact on investments and the stock market today.

What is an Economic Bubble?

Like in the above tulip example, an economic bubble is when the price of an asset or multiple assets, including securities, go beyond its intrinsic value. This usually happens due to higher demand. Just like a bubble that is expanding, these higher prices tend to reach a threshold only to plummet back to their normal prices.

 


What Causes Economic Bubbles?

There isn’t any particular reason for a bubble to happen, but it usually happens when the purchasing power of investors increases. For instance, if an economy is growing, households will have more disposable income due to higher wages and it will result in these households purchasing more assets, which in turn causes higher demand and a price hike.

In the case of stocks and stock markets, a bubble could happen due to a boom in a particular company or sector.

When stock market investors see growth potential, they tend to include such companies in their stocks to buy list and this could hike up their demand.

Five Stages of Economic Bubbles

An economic bubble usually happens in five stages.

1. Displacement – This is a stage where investors follow a new trend in the sector which causes the prices to increase. For instance, suppose if there is a tax cut on vehicles, more people will buy cars, which will cause an increase in their prices.

2. Boom – The trend and investors’ interest in it causes the prices to hike rapidly in this stage.

3. Euphoria – This is a stage when the price of the asset crosses the intrinsic value, but the investors keep investing.

4. Profit-taking – A part of investors sense the bubble burst and start to sell and pocket profits.

5. Panic – This is the stage where the bubble will burst, and the price will start to rapidly go down. The market will be at a stage of panic here.

Historical Economic Bubbles

Bubbles are not exclusive to stock markets today; they have been a part of history for centuries. One of the most prominent examples of an economic bubble is the price hike of tulips mentioned above. Known as tulipmania, this extraordinary price hike happened in the Dutch golden age only to burst in three years.

The dot com Bubble

The late 1990s was a period when the internet was booming, and investors saw a lot of interest in stocks of companies related to the internet. But eventually, investors saw a burst and started selling the stocks for profit, which caused a dramatic downfall of such stocks.

Conclusion

As an investor, you can make use of a bubble to make a profit but the important thing here is to be vary of the burst. A thorough study and understanding of share markets are necessary for this. You can also take the help of a financial expert to understand markets better. Get help and invest today!

 

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