A:

To understand the term "echo bubble", you have to understand what a bubble is. A financial or economic bubble occurs when stocks trade at prices that exceed their intrinsic or true values. A stock trading beyond its true value eventually crashes, resulting in the decline of the stock price.

For example, if stock XYZ is trading at $70, but financial analysts determine that the intrinsic value of the stock is $50, the stock is said to be trading in a bubble. Because investors understand that the market eventually will make a correction, resulting in the stock price falling to its true value, they may begin to short sell the stock for the intrinsic value of $50. When massive sales occur, the stock price is driven down further until the bubble bursts.

An echo bubble is a smaller bubble that succeeds the collapse of a larger one. When a bubble bursts, the market rallies, which causes prices to climb past their intrinsic values, thereby creating another bubble. Therefore, a bubble that forms as a result of a rallying market often is referred to as an echo bubble.

(For more on this topic, read Crashes: Introduction and Understanding Cycles: The Key to Market Timing.)

This question was answered by Chizoba Morah.

RELATED FAQS
  1. What do people mean when they say there is a "bubble" going on in the market, such ...

    A financial "bubble" refers to a situation where there is a relatively high level of trading activity on a particular asset ... Read Answer >>
  2. Can the Efficient Market Hypothesis explain economic bubbles?

    Learn about the nuanced relationship between the efficient market hypothesis and economic bubbles and the requirements and ... Read Answer >>
  3. What economic factors influence corporate bond yields?

    Discover how to notice the early warning signs of a tech bubble. Like most bubbles, a rapid rise in asset values, is usually ... Read Answer >>
  4. What can capitalization rate tell investors about real estate bubbles?

    Learn about capitalization rates and what information investors may glean from them with regard to bubbles. Explore how rates ... Read Answer >>
  5. What lessons did the tech bubble crash give to investors in the Internet sector?

    Learn how investors contributed to the dot-com bust and how Internet services and investing has changed since the market ... Read Answer >>
  6. Do you always have to consider intrinsic value when purchasing a stock? Why or why ...

    Take a deeper look at why value investors consider a stock's intrinsic value an important consideration before picking a ... Read Answer >>
Related Articles
  1. Markets

    Economic Bubble: Toil And Trouble!

    You might like the idea of profiting from a bubble, but you’d probably like to avoid suffering from its aftermath. Here is how an economic bubble works.
  2. Markets

    How Does a Bubble Form and Burst?

    A bubble forms when prices grow beyond their true value.
  3. Markets

    Five Of The Largest Asset Bubbles In History

    The five bubbles discussed here were among the biggest in history; their lessons should be heeded.
  4. Markets

    Should the Fed Be More Worried About Asset Bubbles?

    While the Fed should be concerned that assets bubbles might impact economic stability, monetary policy is not the best tool to mitigate this threat.
  5. Markets

    5 Steps of a Bubble

    In the financial sense, a bubble refers to a situation where the price of an asset far exceeds its fundamental value.
  6. Managing Wealth

    5 Steps Of A Bubble

    Bubbles are deceptive and unpredictable, but by studying their history we can prepare to our best ability.
  7. Markets

    Some Industries Are More Bubbly Than Others

    Investors who want to avoid future bubbles should learn from the past in order to protect their investments.
  8. Managing Wealth

    The Myth About Market Bubbles

    Bubbles have made and ruined fortunes. Though they can be difficult to predict, understanding how they work gives you a visible advantage.
  9. Markets

    How Do Asset Bubbles Cause Recessions?

    Understand how asset bubbles often lead to deep, protracted recessions. Read about historical examples of recessions preceded by asset bubbles.
  10. Markets

    Lessons Learned: Comparing The Japanese And U.S. Bubbles

    Find out what the Japanese and U.S. bubbles can tell us about recovering from financial chaos.
RELATED TERMS
  1. Echo Bubble

    A post-bubble rally that becomes another, smaller bubble. The ...
  2. Bubble Company

    A company whose valuation greatly exceeds that suggested by its ...
  3. Speculative Bubble

    A spike in asset values within a particular industry, commodity, ...
  4. Bubble Theory

    A school of thought that believes that the prices of assets can ...
  5. Bubble

    1. An economic cycle characterized by rapid expansion followed ...
  6. Tech Bubble

    A pronounced and unsustainable market rise attributed to increased ...
Hot Definitions
  1. Bond Ladder

    A portfolio of fixed-income securities in which each security has a significantly different maturity date. The purpose of ...
  2. Duration

    A measure of the sensitivity of the price (the value of principal) of a fixed-income investment to a change in interest rates. ...
  3. Dove

    An economic policy advisor who promotes monetary policies that involve the maintenance of low interest rates, believing that ...
  4. Cyclical Stock

    An equity security whose price is affected by ups and downs in the overall economy. Cyclical stocks typically relate to companies ...
  5. Front Running

    The unethical practice of a broker trading an equity based on information from the analyst department before his or her clients ...
  6. After-Hours Trading - AHT

    Trading after regular trading hours on the major exchanges. The increasing popularity of electronic communication networks ...
Trading Center