Markets and Business
Riding the Hype: Understanding Financial Bubbles
Financial Bubbles??
You’ve probably heard about “bubbles”, but how does this relate to the economy?
A financial bubble happens when the price of an asset, like a stock, rises dramatically, not because of real value but due to speculation. The term “bubble” comes from the fact that when expectations about its growth turn pessimistic, it “bursts,” causing the price to drop quickly.
Let’s walk through an example (in the next section of course...)
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The Example
Imagine you wake up one morning to see that the price of PALL Inc. shares has increased by 5%. Yesterday, they were worth $80, and today they are $84. You might feel surprised, even envious of those who own shares. The next day, the price rises again. More people see the growing value of the shares and decide to buy. As demand for these shares increases, the price goes up again.
Days pass, and you watch the price keep rising. Eventually, you don’t want to miss out, so you decide to invest. Now, PALL Inc. shares are priced at $120—50% higher than just a short time ago. You’re confident the price will continue rising, so you buy in and feel happy about your investment.
The next day, the price climbs even higher to $130. You’ve made $10 per share! You start dreaming of all the things you’ll do with this new money: vacations, house renovations, new sneakers. Everything seems great.
But then, you start asking yourself: What exactly does PALL Inc. do? Where does it make its money? You realize that you’re not sure. You ask around, and no one seems to know. So, you posted the question online, asking If anyone knows what PALL Inc. does.
Soon, more people start doubting the company’s value. As uncertainty grows, shareholders begin selling off their shares. With fewer buyers, the price drops back to $120, where you bought in. You might still have hope, thinking it’s just a temporary drop. But the next day, the price falls further to $100. Now you’ve lost $20 per share.
You’re unsure if the drop will last, but you decide to sell your shares to avoid further losses. The next morning, no one wants to buy the stock at $100. It’s clear now that PALL Inc.’s model isn’t sustainable. Everyone’s worried about losing everything, and the price crashes to just $50 per share. You decide to sell at that price. It’s a sad realization, but at least now you understand a financial bubble.
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Conclusion
This experience shows how bubbles work. Prices rise for speculative reasons, driven by excitement and expectations. But when the reality of the company’s value sets in, prices crash, and investors can face significant losses. This cycle of boom and bust is the essence of a financial bubble.
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The Pallicies Challenge
So, now that you understand bubbles, here’s your challenge:Go to your favorite financial news website or stock tracking app and try to spot something in a bubble. Is there a cryptocurrency, stock, or even a housing market that has been getting much hype lately?
Ask yourself:
Has the price gone up very quickly?
Do people seem more excited about the price than the actual value of the product or company?
Could this excitement burst if new information comes out?
Share your pick with a friend, teacher, or on social media. You might just spot the next PALL Inc. before it pops.
Let the bubble spotting begin!