Historically there have been several famous 'bubbles' where people have invested everything they have in stocks, shares or commodities only to lose everything when the bubble burst. It is characterized by people forgetting that prices can also go down as well as up. By speculating that the prices will only continue to rise, the prices of the stocks cease to be linked to their intrinsic value. When there is no longer anyone prepared to buy at these over-inflated prices the bubble bursts and the buyers are left with worthless stock.

Tulip Mania

In the mid 1630's in the Netherlands there was a huge interest in tulip bulbs, especially bulbs that produced variegated flowers. There was a lot of speculative dealing in these bulbs, and while in the beginning people were exchanging actual bulbs, they later exchanged contracts for bulbs they would receive in the future. This is similar to the way a 'futures market' works today. People became obsessed by the bulbs, and prices continued to rise out of proportion to the real profit represented by the bulbs alone. During the winter of 1636/7 the prices of bulbs rose so high that one bulb was worth about ten times the annual income of a skilled craftsman. Partly due to proposed financial legislation by the Dutch government regarding future contracts, prices abruptly fell in February 1637 and the mania was over.

South Sea Bubble

In the early 1700's the British Government had a large National Debt which varied between £10million and £30million (18 century prices). The South Sea Company, established to explore and make money in the South Seas, in a similar way to the East India Company did in the East, did very little actual trading. This was partly because for most of the time it didn't even have a ship to trade with! However, this lack of trading success didn't prevent it coming up with the novel idea in 1720 of buying the National Debt from the Government as a way to make money in the new financial market of stocks and shares. Shares in the company were floated in the market, with the company even lending money to investors to help them buy up the shares. Anyone who was anyone wanted to take advantage. 'Stockjobbing' became all the rage and people even sold their estates and other assets to get in on the act. Prices rose dramatically by the day as everyone wanted to join in the 'Bubble' with prices peaking at £1100 at the end of July. However by mid September prices had fallen through the floor and shares were being sold at whatever price they could get. Fortunes made in the spring and summer were lost by the fall. Many people went bankrupt or committed suicide. The 'Bubble' had burst.

The Dot-Com Bubble

The dotcom bubble of 1999-2001 was similar to the South Sea Bubble with people buying stocks in Internet companies that had very little in the way of a business plan, never mind any assets. Everything was virtual in a virtual world. For example Yahoo Japan which traded at $1million a share in Tokyo in February 2000, now in late 2010 trades at around $350 a share!

People who get in at the beginning of a 'bubble' and get out before the market peaks can make a lot of money, but a sort of fever takes over and people lose their common sense and are willing to invest in almost anything that moves just to be part of the mirage.

Remember, if your investment opportunity seems too good to be true, it probably is!