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What is an echo bubble?

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.

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