What is a "bubble"?

A bubble is an economic cycle characterized by a rapid escalation in asset prices followed by a decline. It is created by a sharp increase in asset prices, unjustified by asset fundamentals and driven by turbulent market behavior. When none of the investors are willing to buy at the increased price, a massive sell-off occurs, causing the bubble to collapse.

Bubbles form in economies, securities, stock markets and business sectors because of changes in investor behavior. It could be a real shift - as seen in Japan's bubble economy in the 1980s when banks were partially deregulated, or a paradigm shift - that occurred during the dot-com boom of the late 1990s and early 2000s. During the boom, people bought tech stocks at high prices, believing they could sell them at a higher price, until confidence was lost and a major market correction occurred, the crash. Stock market and economic bubbles cause resources to be shifted to high-growth areas. At the end of the bubble, resources are transferred again, causing prices to fall.

Economist Hyman P. Minsky, who was one of the first to explain the development of financial instability and its relationship to the economy, identified five stages in a typical credit cycle. The bubble pattern is quite consistent despite differences in how the cycle is interpreted.

Shift: This stage is when investors begin to see a new paradigm, such as a new product or technology, or historically low interest rates - basically anything that catches their attention.
Boom: Prices start to rise first, then gain momentum as more investors enter the market.
Euphoria: When euphoria sets in and asset prices soar, caution dissipates
Profit taking: To predict when a bubble will burst is not easy. When the bubble bursts, it will not reappear. Anyone who notices the warning signs will make money by selling items.
Panic: Asset prices change course and fall as fast as they rose. Investors want to get rid of them at all costs. Asset prices fall when supply exceeds demand.