Bubble Theory

No one wants their bubble of any kind to burst, particularly in the stock market. The bubble theory is a school of thought that says a stock or other asset can have a rapid rise in price well above its true value. This can go on for years, but without any warning the bubble bursts, causing the price to decline rapidly. Eventually, it could stabilize at a more realistic level.

Think of the “dot bombs” in the 1990s, where investors were frantically trying to throw money at Internet start-ups, even though many had no source of revenue. Eventually that bubble burst, leaving many with worthless stocks.

Besides the stock market, the bubble theory can take place in commodities, a particular industry, the housing market, or in a really comfortable bathtub. To avoid bubbles bursting, your best bet might be to avoid “cult stocks” that are overvalued, and stick with those that have healthy financials to back up a high stock price. Also, make sure the water's not too hot before you get in.