Bubbles happen when a specific asset type or closely-linked group of assets suddenly become very popular and significantly grow in value as more and more people are drawn in.
At some point the assets reach their peak value and the bubble will either burst with a big BANG or just slowly decline.
The asset types commonly found at the centre of bubbles include stocks and shares, property, crypto currencies, NFTs and even tulips!
Recently we’ve had meme stocks causing short bubbles and some believe we are in the middle of a crypto currency bubble.
Going further back in time, we had a property bubble before the credit crunch and the dot-com bubble of the early 2000s.
Two of the most famous bubbles from ye olde days are the South Sea Bubble and the Tulip Bubble.
What causes a financial bubble?
There are always lots of factors contributing to a bubble, but it all starts when demand for a particular type of asset starts to quickly outweigh supply and prices begin to rise.
As word gets out that people are making money from the asset, more and more investors pile in to get a piece of the action, which drives up prices again.
Soon the frenzy of rising prices and stories of fortunes being made reaches the mainstream and even more people join the party. This creates further demand and prices again go up.
Some people even borrow money to leverage their investments in the asset. Many more are caught up in FOMO – the fear of missing out.
The cycle continues until it reaches the point where prices peak.
Perhaps something has changed in the market that makes the asset less appealing. Perhaps the price can’t be sustained.
Whatever the cause, as soon as people sense a loss of confidence, they quickly try to sell their assets. But with everyone trying to sell at the same time, supply begins to exceed demand and prices very quickly fall.
At this point the bubble has burst!
Thanks for reading 🙂
Note: While doing this write up, I’ve realised I goofed with the sketchnote. I thought Issac Newton had lost his money in the Tulip Bubble, but I was wrong. It was actually the South Sea Bubble. Fascinating story, but it looks like I need to get better at doing my homework!