What is a financial bubble and what assets are considered financial bubbles?
You've probably often heard the warning that a financial bubble has formed in the market, and many have wondered: what is this phenomenon and why is it dangerous?
A financial bubble is a market situation where the price of an asset rises unreasonably and significantly exceeds its real value.
Typically, this is caused by widespread excitement among investors, who begin actively buying up assets, believing in endless price growth, and make purchases at greatly inflated prices.
The main signs of a financial bubble include: a sharp and inexplicable rise in prices, general optimism among investors without serious grounds, and ignoring obvious risks.
Signs that a financial bubble is about to burst include sharp price fluctuations, negative news, or a sharp drop in trading volumes.
History is replete with examples of financial bubbles. The most famous are the Tulip Mania in 17th-century Holland, when tulip bulb prices reached incredible heights and then plummeted, and the Dot-com Bubble in the US in the early 2000s, when internet stocks soared without any economic basis and then crashed, leaving many investors with nothing.
Assets that most often become financial bubbles
There are certain categories of assets with a higher risk of a sharp price decline, and you should be extremely careful when purchasing them.
Cryptocurrencies - The most striking example in recent years is cryptocurrencies such as Bitcoin, Ethereum, and especially various meme tokens. Their prices often rise due to enthusiasm and faith in technological innovation. But when investors begin to realize that the coin's actual utility is lower than expected, a sharp decline occurs.
Technology stocks - High-growth technology companies and startups are particularly prone to bubbles. Investors invest in these stocks in hopes of huge future profits, but many companies struggle to compete or fail to meet profit expectations, leading to a collapse in their stock prices.
Real Estate - The real estate market periodically experiences financial bubbles. Prices rise rapidly because people believe housing is a safe investment. But if prices diverge significantly from actual housing values and household incomes, a correction and market decline are inevitable sooner or later.
Precious Metals – Surprisingly, even assets like gold and silver sometimes become financial bubbles. People start buying precious metals en masse during times of crisis at inflated prices, believing them to be safe. However, once the panic subsides, prices return to more realistic levels.
How to protect yourself from the consequences of a financial bubble?
To avoid serious losses associated with the bursting of a financial bubble, simple and accessible methods such as stop losses and hedging can be used.
- A stop-loss order is a simple setting on the trading platform that automatically closes your position when a specified loss level is reached. A pending order to close a trade after the price drops will help you avoid large losses.
- Hedging is a method of investment protection where you invest in assets with an inverse correlation. This means that if the value of one asset falls, the other is likely to rise. For example, after buying Bitcoin, you can simultaneously open a trade on the US dollar index, as these two assets have a strong negative correlation. Download a book about hedging investments .
