How to identify a stock market bubble

In 18th-century Europe, tables, doorways, domes, and even wallpapers inspired by pineapples were a fairly common sight. But why were the Europeans crazy about this particular fruit? This phase was known as the pineapple mania. It started around the time they began exploring and colonising Latin America. Europe’s cold climate meant its people had never seen a pineapple. And once they tasted one, they were hooked. And due to its limited supply and overreliance on imports, the price kept rising. Today, you can get pineapples for a dime a dozen. This is a wacky example of an asset bubble. People misattribute a high price to an asset just because it is high in demand. However, the asset’s intrinsic value might be far lower and sentiment surrounding it might be misplaced. Similarly, in stocks, people assign ridiculous prices to certain companies or sectors, expecting prices to keep rising. But after a while, when the fundamentals fail to keep up, it all comes crashing down. What is a stock market bubble? A stock market bubble is a period where asset prices – whether stocks, sectors, or entire markets – rise far above their intrinsic value. The driving force behind this price surge is usually speculation, excessive optimism, and collective behaviour that disregards fundamentals. The bubble ends when the prices correct sharply, often leading to significant losses for those who fail to exit in time. Bubbles are rarely driven by rational market behaviour. Instead, they’re fueled by psychological factors, such as fear of missing out (FOMO), irrational exuberance, and add to that a total disregard for valuation. In the final stages of a bubble, markets become driven by hope and speculation rather than real economic performance. Suggested read: You are not irrational The lifecycle of a typical bubble Economist Hyman P. Minsky identified five stages of a credit cycle – one of the several recurrent economic cycles – in his book Stabilizing an Unstable Economy (1986). His stages closely follow the pattern a bubble follows. 1. Displacement A new trend, technology, or idea captures the market’s imagination. It could be something like artificial intelligence, electric vehicles, or cryptocurrency. Investors and media hype up the potential, attracting early speculators. 2. Boom As the idea gains traction, prices start to rise. Media coverage intensifies, and more investors jump on the bandwagon. There is excitement, and valuations begin to climb, often disconnected from the underlying economic reality. 3. Euphoria At this point, the market is driven by greed. Investors believe the trend will continue indefinitely, and caution is thrown out the window. Fundamentals are ignored, and people begin to take on excessive risk. Prices reach unsustainable levels. 4. Profit-taking Smart investors or institutional players begin to quietly exit the market. They understand the bubble has reached its peak, and they take their profits while there’s still time. However, for retail investors, this sort of instinct-driven investing rarely works. So, they hang on. 5. Panic/Crash The inevitable happens—prices crash. Fear sets in, and investors scramble to sell. The market plunges, liquidity dries up, and panic ensues. Those who didn’t sell in time are left holding assets at far lower prices. Suggested read: True an

This article was originally published on June 11, 2025.