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What is Bubble Theory?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 22 September 2016
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    Conjecture Corporation
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When applied to finances and investment strategies, the bubble theory has to do with the performance of security prices. Essentially, the concept of the bubble theory states that the security price of a given security or group of securities will go through a phase in which the price per unit will rise rapidly and high above the value that is indicated by past performance and current market conditions. Following this rapid upswing in price, the securities will achieve a point where this bubble bursts, and the security price goes into a period of rapid descent.

There are investors who take the idea of the bubble theory very seriously. To that end, some investors will make it a point to look for stocks that are deemed to exhibit some indication of developing a rapid upswing in price in the near future. When the investor finds a stock that he or she feels will soon perform according to the pattern outlined in the bubble theory, the investor will buy as many shares as possible. At that point, the focus is on monitoring the ascent of the security price, and then finding the right time to sell the shares. The idea is to sell the securities just before the price levels out and begins to fall.

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Other investors tend to think that the bubble theory is more wishful thinking than a strategy that can be demonstrated by employing logical approach to evaluating and researching the performance of the stock and the general condition of the current market. Generally, it is easy to point toward specific incidents where a stock was said to about to explode into a period of rapid growth, only to have the stock perform in a much less spectacular manner. At the same time, proponents of the bubble theory will also point to occasions when the rapid rise and fall of the price of a stock was identified, and in fact did come to pass.

Generally, investors tend to approach the bubble theory with a degree of skepticism, at least until there is an incident where the theory seems to prove true. However, most investors tend to rely more upon the application of logic and an understanding of the usual functionality of the stock market when making investment decisions.

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