A lot of talking heads are throwing around the term stock market bubble lately. So exactly does that mean, and are we in one?
Well, there’s no exact definition of a stock market bubble. But throughout history, there have been a few market bubbles you can learn from.
You could also learn from penny stock supernovas. They’re like a tiny example of what you’d see in a stock market bubble. More on that in a bit…
And whether it’s a penny stock supernova or a market bubble, one thing is clear — the bubble always bursts.
Let’s go over what causes a market bubble, as well as indicators and some of the consequences…
Table of Contents
- 1 What Does a Bubble Mean in the Stock Market?
- 2 When Was the Last Stock Market Bubble?
- 3 What Causes a Stock Market Bubble?
- 4 What Are the Consequences of a Stock Market Bubble?
- 5 Stock Market Bubble 2020: Will the Stock Market Crash?
- 6 Learn From the History of Stock Market Bubbles and Crashes
- 7 Frequently Asked Questions About Stock Market Bubbles
- 8 Bottom Line: Can You Benefit From a Market Crash?
What Does a Bubble Mean in the Stock Market?
A stock market bubble is an increase in market valuation based on speculation and investors’ excitement about the future.
Speculative and excited buyers buy into the market at a fast pace, driving stock prices and company values to inflated highs.
A company’s value is usually based on its fundamentals — like income, earnings, or growth. But during a market bubble, prices can increase well above an accepted method of valuation.
When Was the Last Stock Market Bubble?
The last market bubble was in 2008. It was based on speculative investors in the real estate market and subprime mortgages.
When the real estate market was booming, banks let just about anyone borrow to buy or build a home. Subprime mortgages were packaged in with other real estate investment funds.
Once the housing supply topped out, prices started to drop. Then foreclosures were on the rise. But with nobody to buy foreclosed homes, banks were stuck holding liabilities.
Like a domino effect, the decrease in home values brought down stocks related to real estate and banks. Then the collapse of stocks led to the closure of major banks and brought many others close to bankruptcy.
What Causes a Stock Market Bubble?
Basically, buyers cause a bubble. The market’s driven by supply and demand. There’s a limited number of shares for any given company. So if there’s enough demand, stock prices go up.
And like we saw in 2008 when everyone was buying houses, buyers wanted to get in while borrowing was easy and before prices went higher.
Right now, we’re seeing a lot of new traders coming into the market. That’s because the coronavirus crash created opportunities for new traders and investors to enter the market at discount prices.
Combine that with new trading apps like Robinhood and the other major brokerages going commission-free, and you have a lot of new buyers.
New traders could get in with low prices and trade as much as they wanted for ‘free.’ It made trading and investing like a game. And people could do it from right on their smartphones.
But why would investors continue to buy at high prices? There’s a psychological reason. Never underestimate the power of…
Again, a stock market bubble is like a penny stock supernova. Buyers believe the hype. They follow trades and tips on buying stocks instead of recognizing the patterns and using a rule-based strategy.
Continued market highs can give traders a sense of euphoria and FOMO. So they keep buying.
When the buying doesn’t stop, you get a bubble. Stocks become overvalued, based on the belief that there’s no better time than now to buy in. Stock prices fall out of line with the actual company value.
Once prices are overextended, short sellers start jumping in, arguing stocks are overvalued. But since most people in the market are long biased, the buyers outnumber the shorts.
It’s a vicious cycle of prices being bid up. But eventually, something has to give…
Just like in the 2008 housing market, the buying stops when prices are out of reach for the average trader and investor. When there aren’t enough buyers to maintain high prices, those prices have to drop.
To get my alerts on penny stock supernovas, sign up for my no-cost Supernova Alerts.
During the frenzied buying, the so-called experts start to rationalize the gains. Instead of trying to talk sense into investors, most jump on the bandwagon.
They can’t go against the crowd and risk their careers or look like the black sheep calling everyone crazy for buying overvalued stocks.
So, many analysts continue to feed the frenzy with more rationale to keep buying. That can drive an overvalued market even higher.
The government and central banks usually have good intentions when they try to stimulate the economy. They print more money and extend credit at cheaper rates.
But when uneducated investors bring that new money into the markets, it can lead to inflating companies’ values. Especially if everyone’s focused on a particular asset, sector, or stock.
We recently saw this with Tesla, Inc. (NASDAQ: TSLA), from the buying frenzy to the huge value increase.
Is it to the point of hysteria? I don’t know … Maybe electric cars are the future and there’s some justification there. Only time will tell.
What Are the Consequences of a Stock Market Bubble?
Steep Drop in Prices and Major Losses
When the bubble bursts, it creates a steep drop in prices.
That leaves many investors with major losses. Sadly, it’s usually the least-educated investors who buy at the top and end up with the biggest losses.
With the traditional mindset of buying and holding forever, most people who bought late won’t sell when the market starts to correct. Too many wait until the market tanks further. That only adds more fuel to the sell-off.
It’s why I prefer to trade instead of invest. And I never recommend anyone hold and hope. My rule #1 is to cut losses quickly. I have trading rules for a reason. If you stick to the rules, it can help protect you from huge losses.
I trade overly safe and always expect the worst from every penny stock company. As soon as you get overly confident, the market tends to humble you FAST.
Recession or Depression
The biggest stock market bubbles in history led to a recession or depression.
It happens when the poor monetary policy that started the bubble dries up. Or when people lose their life savings, which can lead their losing homes or other property. Declining stock prices affect more than just those who held positions in stocks.
The losses can ripple through the overall economy and affect consumer confidence and even jobs. It can eventually affect the whole country and recovery can take years.
Stock Market Bubble 2020: Will the Stock Market Crash?
There’s a lot of talk about a market bubble right now, with Robinhooders and retail traders driving up prices. Does that mean the market will crash in 2020?
Nobody knows for sure. But we can look at stock market bubble indicators and past market bubbles to give us an idea of the future.
Stock Market Bubble Indicators
One stock market bubble indicator is an increase in initial public offerings (IPOs). Companies want to take advantage of the market highs and exposure to investors at inflated prices.
Some of these companies may even be scams and not live up to the hype they play up to enter the market.
High speculation can be another indicator. Investors enter the market speculating that new and existing companies have higher values.
Many assume that economic or technological changes can increase a stock’s value in the future. Speculators think they’re getting in early…
Now, let’s look at some penny stock supernovas so you can see what a bubble looks like. These supernovas are like a stock market bubble on a smaller scale.
SPI Energy Co., Ltd. (NASDAQ: SPI)
This stock ran from the $3.50s to $46.67 in one day. That insane run happened after SPI announced it was launching an electric vehicle subsidiary. I bought 5,000 shares at $3.52 and sold at $3.71 for a profit of $950*. When it kept showing strength, I rebought 2,000 shares at $10.75 and sold at $11.27 for a profit of $1,040*. As usual, I completely underestimated it.
This is what mass hysteria looks like. Check out the chart:
There’s definitely some shorts getting squeezed as part of the move. That can happen in an overall market bubble too.
Eastman Kodak Company (NYSE: KODK)
Eastman Kodak Company (NYSE: KODK) went from the mid-$9s to $60 in two days. This stock ran on its announcement of securing a government loan. Yep, that’s KODK trying to pivot into pharmaceuticals in the midst of the pandemic.
Here’s another example of what a bubble looks like. Check it out:
If a stock’s up 10–20 times in a short time, it’s probably a bubble. When it bursts, it typically goes right back to where it was before the run started. But that doesn’t necessarily mean I’d short these stocks.
If you’re missing out on opportunities like these, get in my 30-Day Bootcamp. I want to help whip you into market shape. It’s not gonna be easy. You need to come ready to study history. That’s the key to understanding these moves and being prepared to trade them.
Are We in a Stock Market Bubble?
There are some signs that a market bubble might be happening right now … We’ve seen a lot of new traders and investors in the market, new money from government stimulus checks, and a lot of IPOs.
But I’m not sure we’ve seen total madness yet. When I was making my first million during the dot-com bubble, traders and investors would do anything to get in on an internet IPO. It was the hottest ticket around and everyone wanted in.
When you’re in a stock market bubble, the whole country is involved. It’s mass hysteria.
Charles Mackay touches on market hysteria in his book “Extraordinary Popular Delusions and the Madness of Crowds.” During the South Sea stock bubble, people used to crash their horse carts in front of the guy in charge of the stock and pretend to be injured. All to try to get some stock out of him.
(As an Amazon Associate, we earn from qualifying purchases.)
So are we in a market bubble now?
I wouldn’t say it’s as crazy as some have been in the past. But there are some stocks that are a bit high. The market’s reclaimed its highs from before the coronavirus crash, but it’s not wildly high.
There are unknowns about the economy after the shutdown and about a possible vaccine. We could be overvalued or undervalued. It’s a guessing game. And it’s hard to see a bubble when you’re in it.
Stocks can still go higher. Don’t be too quick to start shorting everything.
I prefer to react to the market. Don’t try to predict. Do your research and protect your account. And always cut losses quickly.
Learn From the History of Stock Market Bubbles and Crashes
History doesn’t repeat exactly, but it does rhyme. Too many newbie traders see these penny stock supernovas and say, “I can’t believe it. I’ve never seen anything like this.”
If that’s you, you haven’t studied. These patterns repeat. You must study the past. Read this post about how Tim Grittani made $200,000 in one day trading a repeatable penny stock pattern.* Here are eight more examples of the same pattern. If you’ve studied the past, these penny stock supernovas shouldn’t be a surprise.
There are plenty of big stock market bubbles from history you can study…
In the big tulip bulb bubble in the 1600s, tulip bulb prices were bid up by speculation and hype. Some became worth as much as a large home. But after three years they were only worth the value of the flower.
This is why education, discipline, and patience matter when you trade. You need to resist chasing stocks and hype. Think you missed an opportunity? Use that to learn and study so you can catch the next one.
In the past, the bigger the stock market bubble, the greater the damage when it bursts.
(*These results are not typical. Individual results will vary. Most traders lose money. My top students have the benefit of many years of hard work and dedication. Trading is inherently risky. Always do your due diligence and never risk more than you can afford to lose.)
The stock market is great because you can make $ off it no matter your background or where you are in the world, but I can’t encourage you enough to study & prepare, prepare, prepare as most people lose due to lack of preparation. Be obsessive in your studying & you will improve!
— Timothy Sykes (@timothysykes) September 29, 2020
Frequently Asked Questions About Stock Market Bubbles
Let’s go over some frequently asked questions about stock market bubbles and how to trade them…
What Goes Up When the Stock Market Crashes?
When the markets go down, investors usually look for somewhere “safe” to put their capital, like gold and U.S. Treasury bonds. Some stocks can go up as markets crash, like consumer staples. People still need essentials to live, even during a crash.
What Happens When a Stock Price Goes to Zero?
Usually, before a stock reaches zero, it’s delisted from major exchanges and trades on the OTC markets where it might find interested investors. But when a stock price goes to zero it’s worthless and there’s little chance of the company turning things around.
When Will the Next Stock Market Bubble Burst?
Nobody can predict the future. I prefer to react to the market. We don’t know when it will end, but we do know the markets can’t go straight up forever. Study the past and be ready to react when the time is right. Preparation is key to your success as a trader or investor.
Bottom Line: Can You Benefit From a Market Crash?
The market always changes and moves. There are bear markets, bull markets, corrections, and market bubbles. You have to adapt to learn to trade through it all.
I don’t invest and hold long term. But I still watch the major markets, because three out of four stocks follow the market. Preparation is key so you can be ready to take advantage of any trading opportunity.
I prepare my students for any market in my Trading Challenge. It doesn’t matter if the market’s making new highs or crashing like it did in March 2020. We find the best penny stocks to trade and take advantage of the predictable patterns.
Apply today if you’re ready to learn how we do it.
What do you think about stock market bubbles? Let me know in the comments … I love to hear from you!