Spotting A Stock Market Bubble: Key Signals Investors Should Watch

Identifying a stock market bubble has always been one of the market’s most debated challenges - often obvious in hindsight, yet notoriously difficult to pinpoint in real time. Bubbles typically form when strong economic narratives, rapid price appreciation, and growing investor optimism begin reinforcing one another.

As valuations stretch and speculative behaviour rises, markets may detach from underlying fundamentals, creating conditions that look sustainable until they suddenly aren’t. Understanding the early signals - both technical and behavioural - is essential for investors aiming to navigate euphoric phases without getting caught on the wrong side of a reversal.

Amruta Shinde, Technical & Derivative Analyst at Choice Equity Broking Private Limited, says that a stock market bubble is generally identified through technical signals that reflect unsustainable price behavior and heightened speculative activity. “These signs often include a parabolic rise in prices, extremely overbought readings such as an RSI (relative strength index) consistently above 80, and significant deviations from long-term moving averages—sometimes 30–40 per cent above the 200-day moving average (MA).”

Bubbles also tend to show unusually high trading volumes driven by market enthusiasm, along with momentum divergences where indicators fail to confirm new highs. Additionally, volatility may shift abruptly from calm conditions to sharp, wide-ranging price movements.

“In their later stages, bubbles can form ‘blow-off tops,’ characterized by large price gaps, extended upper wicks, or rapid intraday reversals. When multiple such signals occur together, the market may be entering a bubble phase,” says Shinde.

How To Identify A Market Bubble

Identifying a stock market bubble, thus, involves assessment of several key indicators.

“If stock prices rise too fast too soon without earnings catching up, then it’s a warning sign for investors that a bubble might be in the making. In such a scenario price to earnings ratios reach historical extremes, thus indicating overvaluation,” informs Abhishek Kumar, Founder of SahajMoney.

Another indicator is the widespread belief that prices will never fall, and that makes first-time investors join the euphoria because of the fear of missing out. This is also reflected in the new account openings with brokerage and social media chatter about stocks.

“When people start believing that stock prices would not fall, then they use margin trading to trade with money that they don’t have by taking loans at high interest rates. But it’s a double-edged sword and leverage cuts both ways, as it magnifies both gains during rallies and losses during market collapses,” says Kumar.

Additionally, when a few stocks or sectors drive a majority of returns, then it indicates that investors are perhaps going with narratives rather than investing based on thorough analysis.

Finally, when investors dismiss historical warnings by arguing that this time it’s different, then it’s highly likely that they have set aside rationality and are going with the euphoria observed during such periods.

Are We Heading For A Bubble?

Thankfully, according to market experts, the current behaviour of the Nifty index does not reflect these characteristics. Instead, it shows a stable and well-supported uptrend.

“The index has risen 134 points to reach a new all-time high of 26,310 after retesting its cup-and-handle breakout—typically a constructive continuation pattern. The bullish hammer near its lifetime high indicates steady buying interest rather than excessive speculation,” says Shinde.

Nifty’s close above 26,200 and its position above the 20-day, 50-day, and 200-day EMAs (exponential moving average) suggest trend consistency rather than overextension.

Momentum indicators reinforce this view: the weekly RSI at 64.04 remains strong without signaling extreme conditions, and the MACD’s (moving average convergence divergence) bullish crossover supports ongoing strength. “With nearby support levels well-defined and a measured buy-on-dips approach remaining appropriate, the index currently reflects controlled bullish sentiment rather than signs of a bubble,” observes Shinde.