Economists have long studied the patterns in which financial bubbles form and ultimately burst. While there are always exceptions to the rule, it usually goes as follows.
First, a displacement will occur. This is when something (e.g., a new piece of technology) becomes incredibly popular and attracts the eyes of investors. This is often shaped by society’s evolving culture.
Next, the price of this new paradigm will slowly rise. As more people enter the market, the price will gain momentum and continue moving upwards. Then, as the fear of missing out looms over investors, more will get involved to get their piece of the pie.
The skyrocketing of prices then causes a feeling of euphoria amongst investors. However, over time, valuations begin reaching excessive levels. At this point, the bubble is just on the cusp of popping. This is typically when people start to become a bit fearful and consider pulling their investment.
Finally, when the bubble breaks, investors panic and liquidate. Prices then descend at a rapid rate.
A recent example of a financial bubble would be the Gamestop craze, which you can read up on in an article we wrote in September.
