Website owner: James Miller
The self-perpetuating cycle behind a market bubble
There is a certain self-perpetuating cycle that underlies a particular market phenomenon called a market bubble. Underlying this self-perpetuating cycle is two basic laws:
1. Increased demand for an item causes the price to go up (if the supply remains constant).
2. If the average person sees a strong upward trend in the price of a stock or commodity (for whatever reason the price is rising), he is tempted to buy the stock. He thinks he will buy it and then sell it later at a much higher price and make a lot of easy money. It is a temptation that few mortals can resist.
So what happens now? First, the price of a certain stock or commodity starts rising for whatever reason. Then people start noticing this trend and become interested in it. Some people start buying the item in hope of making money on the trend. The increased buying pressure causes the price to increase even faster. As the price goes up faster even more people start noticing and buying causing the price to increase even faster. With a lot more people wishing to buy than sell, there is a pressure that pushes the price higher and higher. With a bit of time great droves of people are buying in much the same way that a giant school of piranha zero in an a victim. Everyone in a great frenzy of greed is buying and the price has soared to absurd, foolish, ridiculous levels. In their great greed people become blind to the foolishness of what they are doing. Tales are being heard of how some who bought in the beginning are now multimillionaires. Some wiser souls counsel caution but the masses are in a feeding frenzy. Then what happens? Well, something happens that causes some people to question the wisdom of what they are doing, the foolishness of the price they are paying, and they decide to sell. And then enough decide to sell to the point where there are more wishing to sell than to buy causing the price of the item to stop increasing and start declining. And when the price starts to decline everyone realizes that they are foolishly holding a grossly overpriced item and everyone gets the same idea at the same time — everyone wants to sell. And when everyone tries to sell at the same time the bubble pops and the price drops like a lead balloon. And those who bought at foolish prices lose a lot of money.
Market bubbles can occur on single stocks, on particular categories of stocks, or with the entire stock market. They can also occur on commodities and on real estate.
Oct 2018
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