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Bubbles are easy to spot after they pop and hard to spot while you're in one. Here are the signs that history says to watch: valuations, borrowed money, speculation and mood.
A bubble is when prices rise far above what the underlying value can justify, driven mostly by the expectation that prices will keep rising. It's not just a big rally: strong markets can be backed by strong profits.
Famous examples include the dot-com bubble that peaked in 2000 and the US housing bubble before 2008. In both, the story was partly true (the internet did change the world; people do need homes), but prices ran far ahead of reality.
When investors pay much more than usual for each dollar of profit, risk rises. Measures like the P/E ratio, the cyclically adjusted P/E (CAPE) and total stock market value compared with the size of the economy help show when prices are stretched.
High valuations can last for years, so they are a warning, not a timing tool.
Bubbles are fuelled by leverage. Rising margin debt, heavy use of options and leveraged products, and record borrowing to buy assets all mean that a fall can turn into forced selling.
When prices drop, leveraged investors may be forced to sell, which pushes prices down further. That's why borrowed money turns corrections into crashes.
Watch for a flood of new listings and IPOs, unprofitable companies soaring, meme stocks, new coins appearing daily, and people with no experience quitting their jobs to trade. When everyone talks about how easy it is to get rich, caution is wise.
Speculative corners of the market usually crack first and hardest.
Sentiment surveys and indexes like Fear & Greed measure the mood of investors. Extreme greed for a long time, very low volatility and the belief that “this time is different” are classic late-bubble signs.
Contrarians often say: be careful when others are greedy, and curious when others are fearful.
No one can reliably call the top. Bubbles can inflate much longer than expected, and selling everything early has a cost too. What these signs can do is help you avoid taking on more risk than you can handle at the worst time.
Practical steps: keep an emergency fund, avoid leverage, rebalance when one part of your portfolio grows too big, and spread investments across assets. The Finex Market Bubble Detector scores six markets from cool to euphoria with live data and dated sources.
Try it: Market Bubble Detector