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. 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 >>
  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 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 >>
  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 >>
Related Articles
  1. Investing

    How Does a Bubble Form and Burst?

    A bubble forms when prices grow beyond their true value.
  2. 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.
  3. 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.
  4. 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.
  5. 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.
  6. Insights

    5 Steps Of A Bubble

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

    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.
  9. Investing

    A Bond Bubble: CFAs Say We're in One

    Almost 90% of CFAs think the bond market is in bubble territory, a recent poll has found.
  10. Financial Advisor

    Are We Heading for a Real Estate Bubble?

    Housing prices across the United States have been on a steady rise over the past few years. Does this mean we are seeing another bubble?
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. Tech Bubble

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

    1. An economic cycle characterized by rapid expansion followed ...
Hot Definitions
  1. Treynor Ratio

    A ratio developed by Jack Treynor that measures returns earned in excess of that which could have been earned on a riskless ...
  2. Buyback

    The repurchase of outstanding shares (repurchase) by a company in order to reduce the number of shares on the market. Companies ...
  3. Tax Refund

    A tax refund is a refund on taxes paid to an individual or household when the actual tax liability is less than the amount ...
  4. Gross Domestic Product - GDP

    The monetary value of all the finished goods and services produced within a country's borders in a specific time period, ...
  5. Inflation

    The rate at which the general level of prices for goods and services is rising and, consequently, the purchasing power of ...
  6. Merchandising

    Merchandising is any act of promoting goods or services for retail sale, including marketing strategies, display design and ...
Trading Center