Bubble Burst: Repeated Crises in the Financial Market

When it comes to bursting bubbles, many investors feel anxious because this situation often leads to losses, economic downturns, and concerns about their own funds. This phenomenon occurs due to a special economic cycle where market values surge beyond sustainable levels and are followed by unpredictable rapid contractions.

Key Aspects of a Bubble Burst

A bubble burst happens when the prices of assets such as real estate, stocks, or digital currencies soar beyond their intrinsic value. Usually, this inflation is not driven by fundamentals but by excessive speculation, overconfidence among investors for at least a month, and herd behavior entering the market.

When prices rise without justification, reality eventually catches up. Asset prices plummet sharply, catching many investors off guard because the correction is too rapid—like a balloon that bursts after being overinflated. The result is massive financial losses.

Historical Cases: Crises Caused by Bubbles

The 2008 US Subprime Mortgage Crisis

During that period, the US real estate market was booming. Financial institutions offered loans to credit-impaired borrowers to buy homes. Many investors did not buy homes for personal use but for expected returns.

Mortgage-backed securities linked to real estate loans became highly popular, causing rapid market expansion. As home prices increased, the value of these securities also rose.

However, when borrowers began defaulting, the entire system collapsed. Estimated global financial losses from bad debts reached $15 billion. This event served as a warning about the dangers of borrowing to invest in long-term assets using short-term debt.

The 1997 Thai Baht Crisis

At that time, Thailand was experiencing a strong economy. Unusually high interest rates prompted both domestic and foreign investors to pour capital into real estate, expecting quick returns.

The real estate market soared uncontrollably, far from realistic valuation. On July 2, 1997, the Thai baht was devalued, causing foreign debt to skyrocket. Highly leveraged real estate markets could no longer sustain the bubble, which burst violently.

Property prices plummeted, and investors with massive debts could not repay. Thailand’s economy plunged into severe recession. The lesson from this crisis is to avoid borrowing in foreign currencies to buy local assets.

Types of Bubbles Investors Should Watch Out For

Stock Market Bubbles

Happen when stock prices increase excessively beyond normal factors like profits, assets, and business performance. These bubbles can affect individual stocks or entire sectors, sometimes impacting the whole stock market.

Asset Market Bubbles

Extend beyond stocks. Real estate is the most obvious example. When housing prices rise beyond realistic levels, both traditional and digital currencies like Bitcoin and Litecoin can also form bubbles.

Credit Bubbles

Result from rapid expansion of consumer and business loans. Excessive borrowing creates fragility, and any economic downturn can trigger widespread defaults.

Commodity Bubbles

Occur when prices of physical resources such as gold, oil, industrial metals, or agricultural products surge uncontrollably. Heavy trading demand pushes prices beyond sustainable levels, eventually collapsing when demand wanes or supply increases.

Why Do Bubbles Occur?

Bubbles often start from positive factors like low interest rates, strong economic conditions, new technologies, or asset shortages. When combined, these factors can fuel bubble formation.

Investors see rising prices and rush in for fear of missing out. Short-term speculation becomes the main driver of prices, rather than fundamentals.

Psychological biases such as herd mentality, excessive optimism, and false beliefs that they can exit before the collapse further inflate the bubble.

Growth and Collapse Phases of a Bubble

Initial Stage: Prices start rising with new and exciting developments in the market—be it technology, new monetary policies, or promising industries.

Upswing: Investors flood into assets fearing missed opportunities, pushing prices higher. This creates a positive feedback loop: rising prices boost confidence, which leads to more buying, further increasing prices.

Excitement Phase: During this period, investors encourage others to buy without caution. Everyone believes prices will keep rising. Speculation intensifies, prices become overinflated, yet confidence remains high.

Profit-Taking: Some investors recognize the abnormal price surge and start selling. Early signs of change appear, volatility increases.

Panic and Collapse: When the majority realize problems are imminent, panic selling ensues. Everyone rushes to exit positions, causing prices to fall freely. The bubble officially bursts.

How to Protect Yourself from a Bubble Burst

Review Your Investment Goals: Before investing, think carefully. Are you investing for solid reasons or just to avoid missing out? If the latter, you might unknowingly support a bubble.

Diversify Risks: Don’t put all your eggs in one basket. Diversification helps reduce risk. When one asset falls, others may offset the loss.

Limit Speculative Investments: If you suspect a bubble is forming, restrict exposure to high-risk assets. These tend to fall fastest when the bubble bursts.

Invest Gradually: Instead of investing all at once, divide your investment over multiple times—this is called Dollar Cost Averaging. It reduces the risk of buying at peak prices.

Keep Cash Reserves: Having liquidity allows you to capitalize on opportunities after the bubble bursts. It also provides a safety net if you need to sell.

Learn and Monitor the Market: The best protection is knowledge. Follow news and data, understand the markets you invest in. Conduct thorough research before any investment.

Summary

Bubbles occur when asset prices exceed their true value. Early in a bubble, prices are driven up by demand and shortages. As investors see prices rising, they rush in, hoping for further gains.

However, this inflation cannot last forever. Eventually, people realize prices are unrealistic, demand wanes, and as investors start selling, prices collapse rapidly—bursting the bubble.

Bubbles are recurring phenomena throughout financial history—dot-com bubbles, real estate bubbles, commodity bubbles. The key lesson is that smart investors should stay prepared by studying markets, diversifying, and avoiding emotional investments.