How to identify a stock market bubble?

​A stock market bubble is a type of economic bubble that occurs when the prices of stocks or other assets far exceed their intrinsic or fundamental value. Bubbles are driven by investor sentiment and psychology, which generate a positive feedback loop of rising prices and additional buying. The bubble inflates until stock prices reach a level beyond economic or fundamental rationality, and/or when the new investment flows that would be necessary from investors and speculators to drive further price increases actually dries up. When no more investors can be found to invest at that price level, the bubble usually begins to collapse.

Identifying a stock market bubble can be challenging, as there is no definitive measure of what constitutes a fair value for an asset. However, some possible indicators of a bubble are:

• High valuation ratios: Valuation ratios, such as price-to-earnings (P/E), price-to-book (P/B), or price-to-sales (P/S), can help compare the current price of a stock to its earnings, assets, or revenues. When these ratios are significantly higher than their historical averages or industry benchmarks, it may indicate that the stock is overvalued and trading at a premium that is not justified by its fundamentals.
 
• Excessive speculation: Speculation is the act of buying or selling an asset based on the expectation of future price movements, rather than on its intrinsic value or utility. When speculation becomes rampant and dominates the market activity, it may signal that investors are chasing returns and ignoring risks. Speculation can also lead to increased volatility and leverage, as investors use borrowed money or derivatives to amplify their bets on the market direction.
 
• Irrational exuberance: Irrational exuberance is a term coined by former Federal Reserve Chairman Alan Greenspan of the United States to describe the behavior of investors who become overly optimistic and enthusiastic about the market prospects, regardless of the underlying fundamentals or realities. Irrational exuberance can manifest in various ways, such as ignoring negative news or data, dismissing alternative views or opinions, following the herd mentality or FOMO (fear of missing out), or believing in new paradigms or narratives that justify the high prices.
 
These are some of the possible indicators of a stock market bubble, but they are not conclusive or foolproof. Bubbles can last longer than expected and defy rational analysis. Therefore, investors should be cautious and diligent when investing in the stock market and avoid being swayed by emotions or hype.