A Classic Bubble Wave

Classic Bubble Wave

Classic Bubble Wave

Whenever I post about a set-up for a bubble wave or bubble formation, I’m talking about a move that looks pretty much like the lighter lines in this chart. They can occur on all time scales.

The darker line is a smoothed Sornette bubble curve.

All bubbles begin with a credible story about why a market must go up. A long-term bubble is always characterized by exogenous capital flows into a market. Bubbles are self-reinforcing due to herding, and price becomes disconnected from reality.

Bubbles are ultimately fragile because of weakness in internal market structure. Sornette has shown that 60% of bubbles end with a crash of 15% or more. Some crashes retrace over 60%. Bubbles that don’t immediately end in a crash frequently go on to become bigger bubbles that end in a crash.

The illustration in this post shows a bubble in foreign capital inflow into the U.S. as part of the dot.com bubble that ended in 2000.