What are bubbles and crashes?
Normally the price of a share, a plot of land or another asset stays roughly connected to what it earns or how useful it is. In a bubble that link breaks. People stop asking “what will this earn?” and ask “what can I sell it for tomorrow?”. Prices rise because prices are rising.
This cycle cannot go on for ever, because sooner or later new buyers run out. Then some people start selling, prices fall, fear spreads and everyone wants out at once. That is a crash. A bubble usually inflates slowly, over months or years, but bursts much faster.
Say land prices in an area start rising on news that a new road will be built. At first the reason makes sense. But then people start buying land only to sell it at a higher price next month. Nobody is building houses; plots just change hands, and prices quadruple in three years. Then one day word comes that the road has been delayed, the buyers vanish, and whoever bought last cannot sell at all. The story is made up.
Why it matters to an investor
- Those who come in last lose most: late in a bubble prices are highest, and that is exactly when the most new investors arrive.
- Big falls are very hard to recover from: if a price halves, it has to double to get back.
- Borrowing multiplies the damage: in a fall the loan still has to be repaid, whatever the price.
- History keeps repeating: technology, land, shares, coins, the asset changes, but the pattern of human behaviour stays much the same.
The stages a bubble usually goes through
Drawing on the ideas of the economist Hyman Minsky, the historian Charles Kindleberger described some common stages of a bubble in his book “Manias, Panics, and Crashes”. No two bubbles are exactly alike, but the pattern often fits.
- The starting story: a new technology, a new policy or a new opportunity, with a genuine reason for optimism.
- The boom: prices rise, borrowing gets easier, the subject spreads through the news and conversation.
- Euphoria: you hear “this time is different”, people who have never invested before come in, and nobody looks at whether prices match earnings.
- Unease and panic: experienced players quietly start selling, prices stall, then a sudden fall and everyone rushes for the exit.
Two big examples in Bangladesh
1996: according to The Daily Star, the Dhaka Stock Exchange’s share price index of the time reached 3,648.75 points on 5 November 1996. The fall began the very next day, and by May 1999 the index was down to 462 points, about 87% below its peak.
2010: the Dhaka Stock Exchange general index (DGEN) hit a record 8,918.51 points on 5 December 2010. On 19 December it fell about 6.72% in a single day, and by early February 2011 it was more than 24% below the peak. In 2010 alone, about 1.5 million new investors had entered the market, many with borrowed money.
Globally: the dot-com bubble
In the late 1990s there was enormous excitement worldwide about internet companies. Many had little revenue, let alone profit, yet adding “.com” to a name was enough to lift the price. America’s technology-heavy Nasdaq index closed at about 5,049 points on 10 March 2000, then fell to about 1,114 on 9 October 2002, a drop of about 78%.
The interesting part is that the hope about the internet was not wrong; the internet really did change the world. The mistake was in the prices. A technology being good and its shares being worth buying at any price are not the same thing.
Source: The Daily Star (2015), Al Jazeera (February 2011), Wikipedia (Nasdaq); details in the sources below
See the numbers as a table
| Fall | |
|---|---|
| DSE, Nov 1996 – May 1999 | 87% |
| Nasdaq, Mar 2000 – Oct 2002 | 78% |
| DSE, Dec 2010 – Feb 2011 (first two months) | 24% |
Worked example
- Say your investment is worth Tk 1,00,000. A 20% fall leaves Tk 80,000. To get back, Tk 80,000 must gain Tk 20,000: a 25% rise.
- A 50% fall leaves Tk 50,000. To get back it has to double: a 100% rise.
- A fall of about 87%, like 1996, leaves only about Tk 13,000. To get back it has to grow about 7.7 times: a rise of about 670%.
Result: the bigger the fall, the much larger the percentage rise needed to recover, and it can take many years. That is why having all your money in one place at the top of a bubble is so risky. The numbers are only an example.
See the numbers as a table
| Fall | Rise needed to recover | |
|---|---|---|
| A 20% fall | 20% | 25% |
| A 50% fall | 50% | 100% |
| An 87% fall | 87% | 670% |
Common mistakes
- Believing “this time is different” without checking it.
- Buying only because the price is rising, without comparing it with earnings or real worth.
- Investing with borrowed money, or with all your savings in one place, during a bubble.
- Assuming “I’ll get out in time once it starts falling”. In a crash everyone wants out at once, and buyers are hard to find.
Don’t buy just because the price is rising. Bubbles inflate slowly and burst quickly, and recovering from a big fall takes a far bigger rise than the fall itself.