Asset Bubble: Things to Know
Asset Bubbles when prices of assets rise far above their true value, mostly due to sentiment rather than fundamentals. A sharp rise in prices if often followed by a drastic drop, which is when the bubble bursts. Typically, bubbles are short lived and have little long term impact on asset prices. This often lead to some people making it very rich while some are left pondering about their entry into this bubble. And often, there are a group of people who in greed of more profit witness the bubble burst instead of coming out of the cycle with realistic profits.
Identify Bubble: Asset prices bubbles are typically classified only in hindsight after prices collapse. While there is no scientific way of identifying, some broad indicators have emerged over the years. Here is when you should be wary.
Asset prices move upwards without a break; Generally in any market, asset prices go through ups and downs even in times of growth. If asset prices are moving up for long time without a significant break, one must be cautious. Investment decisions are usually made within the confines of professional offices. When such discussions start happening at social gatherings of unrelated people, it points to widespread interest among the general public. If everyone is talking about a particular stock or asset, you need to be careful.
Things to Watch Out: If everyone is making money and no one is talking about losing money, clearly prices have been moving upwards for a long time. This is a time when you know that the bubble could take a U-turn anytime soon. Herd behavior from investors accentuates asset bubbles. So if you suspect a price bubble in any asset, the rule of thumb should be not to do what everyone is doing and not follow the herd.