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CFDs come with a high risk of losing money rapidly due to leverage. 71% of accounts lose money when trading CFDs with this provider. You should understand how CFDs work and consider if you can take the risk of losing your money.

CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 71% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.

71% of retail investor accounts lose money when trading CFDs with this provider.

Trading Terms

A history of market bubbles and speculative manias

a history of market bubbles image representation

What is a financial market bubble?

Market bubbles are a phenomenon that occurs when prices of a financial security or asset class experience enormous growth over a short period of time.

With speculation and crowd psychology fueling the momentum of the rally, the price bubble continues to expand until it eventually bursts.

Economist Robert Shiller popularised the term irrational exuberance to explain the excessive buying behaviour and undue economic optimism that drives the speculative frenzy.

This article will focus on the following:

  • The role of speculation in global markets
  • A history of market bubbles
  • Causes and consequences of modern day bubbles

Several factors and dynamics contribute to the formation and bursting of bubbles: Historically, there have been several well-documented bubbles, such as the Tulip Mania in the 17th century, the Dot-com bubble in the late 1990s and early 2000s, and the US housing bubble in the mid-2000s.

Each of these bubbles had unique, yet devastating consequences once they burst, leading to economic recessions, bankruptcies, and significant financial losses for many investors.

Detecting a bubble with certainty in real-time is challenging, as it's hard to differentiate between justified optimism and irrational exuberance. However, understanding the dynamics that lead to bubbles can help investors navigate risky market environments.

Several factors and dynamics contribute to the formation and bursting of bubbles

Additional reading: Five stages of a market bubble: The Hyman Minsky Model

A history of speculative market bubbles

Tulip Mania - The Dutch tulip bubble (1634 - 1637)

The first documented occurrence of a speculative bubble was the 17th century Dutch tulip bubble (also known as ‘tulip mania)’. With the rapid demand for tulip bulbs leading to a massive surge in prices between 1634 and 1636, the Dutch economy suffered when the prices of tulip bulbs tumbled in February 1637.

The South Sea Bubble (1720)

Rights for the South Sea company soared when the company was granted exclusive rights to trade in the South Sea. Stocks for the company collapsed around 1720.

Mississippi Company Bubble (1719 - 1720)

Between 1719 and 1720 the company had monopolistic rights over trading with French colonies. Throughout 1719 the stock price surged until valuations could no longer justify the share price causing the bubble to burst in 1720.

Railroad Mania (1840)

The introduction of railroads in the 1840’s caused stocks of British railroad companies to surge on expectations that the technology would continue to transform the economy. With the increase in competition limiting profits, the railroad sector contracted causing many companies to fail.ç

Modern Day Market Bubbles

WIth the introduction of computers and advances in technology allowing for closer collaboration between global economies, the impact of modern day bubbles is rarely isolated to a single economy.

A few of the market bubbles that have developed in the 21st century include:

A few of the market bubbles that have developed in the 21st century

Conclusion

  1. Market bubbles occur when the price of an asset surpasses its intrinsic value
  2. Speculation and crowd psychology are primary drivers of the price increases
  3. When the bubble bursts, it often results in financial losses for many investors
  4. Historically, market bubbles have contributed to previous recessions
  5. As the realm of finance continues to adjust, it is possible for more bubbles to occur as technology and innovation pave the way for new products and opportunities

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Past performance does not guarantee or predict future performance. This article is offered for general information and does not constitute investment advice. Please be informed that currently, Skilling is only offering CFDs.