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 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 >>
  4. 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 >>
  5. 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 >>
  6. What are the typical factors that cause the economy to repeat a boom and bust cycle?

    Read about the fundamental causes of the economic boom-bust cycle, why some recessions are necessary and why asset bubbles ... Read Answer >>
Related Articles
  1. Investing

    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. Investing

    How Does a Bubble Form and Burst?

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

    Talking to Clients Who Think Stocks Are in a Bubble

    Here's what to tell clients who think that the market is in bubble territory.
  4. Insights

    Five Of The Largest Asset Bubbles In History

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

    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.
  6. Insights

    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.
  7. Insights

    5 Ways To Spot The Next Stock Bubble - And Avoid It

    Playing a market bubble could pay off, but it carries a lot of risk. Avoiding it could be the way to stay profitable.
  8. Insights

    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.
  9. Insights

    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.
  10. Insights

    5 Steps Of A Bubble

    Bubbles are deceptive and unpredictable, but by studying their history we can prepare to our best ability.
RELATED TERMS
  1. Bubble Company

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

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

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

    A pronounced and unsustainable market rise attributed to increased ...
  5. Bubble

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

    A run-up in housing prices fueled by demand, speculation and ...
Hot Definitions
  1. Dividend Yield

    A financial ratio that shows how much a company pays out in dividends each year relative to its share price.
  2. Fixed-Income Security

    An investment that provides a return in the form of fixed periodic payments and the eventual return of principal at maturity. ...
  3. Free Cash Flow - FCF

    A measure of financial performance calculated as operating cash flow minus capital expenditures. Free cash flow (FCF) represents ...
  4. Leverage Ratio

    Any ratio used to calculate the financial leverage of a company to get an idea of the company's methods of financing or to ...
  5. Two And Twenty

    A type of compensation structure that hedge fund managers typically employ in which part of compensation is performance based. ...
  6. Market Capitalization

    The total dollar market value of all of a company's outstanding shares. Market capitalization is calculated by multiplying ...
Trading Center