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What Does "Melt up" Mean?

Jim B.
Jim B.

In the world of finance, a "melt up" occurs when there is a sudden and dramatic rise in the prices of a specific asset class like stocks or bonds. This rise is driven for the most part by investors buying the assets so that they don't miss out on the rising tide. The problem with a "melt up" is that is driven more by momentum than by any significant change in the financial outlook. When investors realize that the fundamentals behind the assets cannot support the rising prices, a sell-off may begin which leads to the opposite effect, a "meltdown."

Investors have different ways of choosing the financial instruments in which they choose to invest. Some choose to look at the fundamental statistics behind the companies or institutions issuing stocks and bonds, choosing only those companies which have strong financial indicators and excellent intangibles behind them. Other investors look for market trends, attempting to get on board when a wave of momentum sweeps up all assets in its path to higher prices. The latter investors are most likely to be the cause of a financial "melt up."

Man climbing a rope
Man climbing a rope

When prices rise for certain assets unexpectedly, it might be the sign of a "melt up" in progress. What usually occurs is that trend-seeking investors will notice the rising prices and, unwilling to miss out on the golden opportunity, start buying as a result. Those investors in short positions, meaning that they are in the process of selling the assets on the rise, might also wish to hedge their positions by buying instead. As a result, the market surges significantly.

It is important to understand that not all surges in a market are signs of a "melt up." This phenomenon is only present when the underlying financial situation does not support the rising prices. Indicators like company earnings, interest rates, unemployment, inflation, and other key macroeconomic components will likely be pointing in the opposite direction of the price move in a typical situation of prices "melting up."

The other defining characteristic of a "melt up" is that is destined to ultimately peter out. When that occurs, panic selling may occur from investors worried about getting caught on the wrong side of the trend. All of this leads to the momentum heading steadily downward to the point where prices may even drop below where they were when the prices started rising. For that reason, investors must either watch financial fundamentals closely or act with expert timing to prevent being damaged by a meltdown.

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