Updated: Jan 11
We're not talking about the bubbles that you used to blow as a kid or the bubbles that come from having a relaxing bath. We're talking about the bubble that can have distractions financial consequences if the bubble is popped-and you are in it. You don't want to be caught in this bubble.
What Type of Bubble Are we Talking About?
A 10 letter word. Well more like 17 if you count the "Bubbles". We're talking about Investment Bubbles.
An investment bubble occurs when high market activity drives prices of an asset beyond its fundamental value. This causes inflation that is solely thriving on the demand of the investors and those who continue to buy the asset at high prices.
Eventually, the investors will no longer be willing to buy that asset since the price has reached a level of of economic irrationality that is ultimately unjustifiable. Consequently, the bubble begins to collapse having disastrous effects on other industries.
In fact, Alan Greenspan coined the term of “irrational exuberance” during the dot-com bubble in an effort to warn that the stock market may be overvalued. Irrational exuberance is a problem as the rise in prices will lead to an inevitable downfall, prompting huge losses for participants. Furthermore, the downfall may also cause widespread market panic.
The Dotcom bubble was fueled by cheap money, easy capital, overconfidence, and overspeculation. Although many dotcoms were generating no profits or revenues, investors continued to buy due to the herding instinct. Their fear of being alone while everyone was rushing to buy the stocks overshadowed the ground rules of investing. With no returns, investment capital began to dry up and people sold their shares to combat their losses. This led to panic selling and eventually, the bursting of the bubble.
Relationship between Herding and Investment Bubbles
Herding is due to the human tendency to wanting to be in the crowd, even if it means disregarding individual judgement sometimes. The fear of being alone coupled with the fear of missing out (FOMO) provokes many investors to follow the herd, even if it goes against their personal discernment.
If someone you know is following an investment bubble, chances are due to herding-you might follow to. The last thing you want to do is become a sheep investor.
Want to check out more tips about not falling into this "bubble"? Check out our behaviorism section!