What is a Stock Market Bubble?

For those who are not familiar with what a stock market bubble means, they should know that as the name implies it takes place in stock markets. Stock market bubbles represent just a part of a larger class, economic bubbles. An economic bubble occurs when prices are inflated, meaning that they are not justified by the intrinsic value of the assets traded. Specialists are not sure what determines such financial bubbles or balloons to occur.

Mathematical approaches have been made to explain this speculative mania alongside the economic ones. These two methods have several points in common. Mathematical approach refers to the asset price bubble as the difference between the real value and the value they are sold for. This price is constantly boosted by investors who speculate additional increase.

How do stock market bubbles form? Why do stock bubbles form? These two questions are very difficult to answer. Some financial analysts find the latter impossible to give a satisfying explanation. Some analysts blame it on people’s greed. The flow of events goes something like this: when someone shows interest in a company’s shares, they become attractive to the other players too. Then they decide to invest in shares themselves, and prices begin to rise all of a sudden. That is a natural effect because a great demand should mean that the assets are valuable. Then is the moment the greed factor gets into the picture. Investors decide to hold selling back until the pick of the value is reached. But speculation does not justify the inflated prices, and the intrinsic value of the assets is obviously lower than the trade worth.

All this process takes place in the case of irrational investors, but in the case of a rational market the stock market bubble can not be explained but for the unpredictability of the future. For a better understanding a great example would be the 1929’th Wall Street crash. A speculative boom led to a national hysteria. A great number of people decided to invest in the stock market as a way of becoming rich overnight. People got more and more loans to invest, because they were highly encouraged by shares’ prices. This led to further increase of prices, not justified at all by their face value. They did not sell hopping for a greater profit. All of a sudden the price began to decrease and created panic.

In the difficult period of time that followed immediately after, previous investments in the gold bullion market proved to be the safest ones. During the Great Depression gold was the only means of protection against bankruptcy, due to the intrinsic value of the precious metal.

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