Hello Everyone, 

I love this place and everything about it. I am sort of newish out here and writing this post in deep inferiority complex. 

The quality of posts / content on this platform are so awesome that I am putting this content with hesitation. 

So Here I go,

I was surfing Quora and saw a question on 

How can a share market bubble happen?

Now with what happened in stock markets yesterday as well as what is perhaps happening in highly valued private companies, I thought of writing a piece on it. Let me qualify by saying that I am in no way predicting any stock or private company collapse – it’s a generic note dealing with Bubbles. 

It starts from a girl in an Indian village called Nimmi. 

A girl named Nimmi from the village used to go to a riverbank to play with her friends every day. One day she found a blue color rock near the riverbank, which out of curiosity she brought home. It was a small soft rock and she placed it into her water glass, which was empty at that time. Her Mother came and like everyday poured freshly made lemonade into the glass without knowing it had that small rock in it. Nimmi also forgot about the rock and drank the lemonade, as she was quite thirsty. While drinking lemonade she said to her Mother, what delicious lemonade today. Her Mother smiled and wondered it’s just the usual one. 

Once the lemonade was about to get over Nimmi saw the stone there and was quick to figure out the reason for the special taste. The blue rock worked like some special salt. It gave it a nice taste and different flavour.  

Next day Nimmi ran towards the river bank and collected as many Blue Rocks as possible and kept them safely in her bag at home. Later when some friends came to her place she made Lemonade for them and sprinkled a little bit of crushed blue rock in their glasses. Her friends when they drank the lemonade were over joyed and kept asking or more.

By now Nimmi realized that she had made an an awesome discovery and thought of making some extra money by selling homemade lemonade outside her house every afternoon. She borrowed Rs. 10 from her mother to buy lemons and made 30 glasses of lemonade each with a price of Re 1. She then sprinkled some of her blue rock salt and sat outside her house with a small banner which read Fresh Lemonade in just Re 1.

In about 1 Hour all of this, all the Lemonade was sold, with some people even drinking 3 to 4 glasses each. Nimmi was elated and so was her mother. She gave back Rs 10 to her mother and still saved Rs 20 for herself. Next day she bought Lemons worth Rs 20, made 60 glasses of Lemonade and made Rs. 40. In a matter of few days entire village knew about this lemonade and started to queue up in front of her house every afternoon to drink it. Nimmi was smart, she didn’t tell anyone about her special ingredient, which was free of cost and available in abundant quantities to her. 

One day a rich man from the city was visiting the village and hearing praises about Nimmi’s lemonade, visited her. He also drank the lemonade and was quite impressed with the taste. He said he had many kinds of lemonades in the city but this was truly a different flavor and one of the most delicious ones. The rich man spoke to Nimmi’s family that he would like to make this lemonade in the city also. Nimmi’s family was first reluctant but then realising the potential of Nimmi’s lemonade, they decided to move to the city where Nimmi and the rich man could produce this Lemonade for more people. 

In the City they started making Lemonade, which soon became a big hit. The rich man then thought of starting a company to make Nimmi’s Lemonade in a large-scale plant. To do that he needed a large investment, which even he didn’t have and was not in favor of taking a loan. So he went around the city to his friends and other people telling them about his plans to to mass produce Nimmi’s Lemonade in order to sell it all across country.  In return for their investment he offered them share/s in the company. 

Some of them agreed and became shareholders in that company. In some time the rich man had enough money to set up a large-scale plant to produce Nimmi’s Lemonade. In next 6 months the plant became operational and the company started to sell it to nearby cities. It soon became a bit hit and the company started to make huge profits. The people who invested in the company in the form of shares were very happy and couldn’t stop talking about it. 

It made a lot of other people who had not invested in this company jealous and they wanted to to invest now. But there was a problem; the company no longer needed any money. But some people desperately wanted to invest in it as they wanted to be part of the explosive growth the company was experiencing. So they went to the people who already owned shares of the company and asked them to sell their shares to them. They knew that existing share-holders would only sell in case they were paid a handsome amount. Some shareholders agreed to sell and the new shareholders bought the shares thinking they would be able to sell these shares to other people after making a nice profit from it. Over the next year Nimmi’s Lemonade continued its journey of rising popularity and now the company started to sell all across country with plans of selling it in other countries as well. 

Loads of people wanted to buy the shares of the company at whatever price. Existing shareholders were selling their shares at sky high prices. 

The demand for the shares, alongwith prices reached astronomical proportions.

A Bubble was forming and growing in size.  

Amongst all this hoopla, looking at the popularity of Nimmi’s lemonade a lot of other people were trying to find out the reason for the taste of the drink and some of them found out that it is primarily because of a blue stone which was easily available, free of cost. A few companies started to produce this lemonade thinking they will also make it as big as that company. 

The turning point was around the corner – the moment people said there’s a similar Lemonade available by other companies as well, gradually the growth of Nimmi’s company slowed down. Competition started to eat away in its territory by giving discounts, offers or just by reaching to places where Nimmi’s company wasn’t there. This was a huge setback for the new shareholders of the company who bought the shares thinking that the company will continue to maintain its high growth. The news of company slowing down spread like wildfire and all of a sudden no one wanted to own the shares of Nimmi’s company. 

Existing shareholders panicked and wanted to sell their shares at any cost. This resulted in oversupply of shares – further depressing the share prices. Across the board people just wanted to sell the shares of Nimmi’s company. 

A company, which was darling of investors just some time ago, suddenly became a company which nobody wanted to invest in. The share prices, which were touching the sky, took a vertical drop and in the popular terminology – the bubble burst.

So what happened?

People saw potential in a company, they started investing in it and saw quick returns. That prompted others to invest in that company with expectation of making quick returns. This becomes a self sustaining cycle and goes on till one day, it stops abruptly because of one bad news.

The moment the cycle stops, things get worse rapidly. When people see that the bubble has burst they want to exit at any cost, which further fuels the downfall of the share price.

Generally speaking no matter how quick the bubbles are formed, the speed at which it busts is always quicker.

Bubble Formation & Burst Cycle – Rough Picture

Bubble Formation: Discovery -> Euphoria -> Irrational Exuberance

Bubble Burst: Panic -> Depression -> Stability. 

Thanks a lot for reading this. Hope you this less bad than I imagine it to be. 

Forever Grateful

Ashish, 

I am Kollectifying, will you 

@Kollectify