A bubble is a market condition in which the price of an asset or group of assets inflates to levels that far exceed their intrinsic value. This occurs when excessive investor enthusiasm and speculation drive prices higher, often disconnected from the fundamental performance of the underlying assets. Bubbles can form in any asset class, including stocks, real estate, commodities or digital assets like cryptocurrencies.
In the early stages of a bubble, rising prices attract more investors, further fuelling demand and creating an upward spiral. Investors, often motivated by the fear of missing out (FOMO), may ignore traditional valuation measures and assume that prices will continue to rise indefinitely. However, this unsustainable growth typically leads to a sharp correction once investors realise that the prices are no longer justified by the underlying value. The collapse of a bubble can result in a sudden and severe drop in asset prices, leading to significant financial losses for those caught in the downturn.
Bubbles often emerge in environments where there is an abundance of liquidity, low interest rates or widespread speculation. While they may provide opportunities for short-term gains, bubbles are generally considered risky due to their unpredictable nature and the likelihood of a sharp reversal. Understanding the signs of a bubble, such as irrational exuberance and disconnect from fundamentals, is critical for investors looking to protect their portfolios from potential market crashes.
This Trustnet Learn article was written with assistance from artificial intelligence (AI). For more information, please visit our AI Statement.