Why Do Stock Markets Crash?
Stockscores Foundation for the week ending July 26, 2021
In this week's issue:
In This Week’s Issue:
- Stockscores Market Minutes Video – Is the Stock Market Going to Crash Soon?
- Stockscores Trader Training – Why Do Stock Markets Crash?
Stockscores Market Minutes – Is the Stock Market Going to Crash Soon?
Recent market volatility has many thinking that another crash is around the corner but are there signs that one is imminent? This week, I show what to look for, provide my analysis of the stock markets, how I find day trades in a summer market and a market scan to find the hot stocks of the day.
Click here to watch this week's Market Minutes video
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Commentary of the Week – Why Do Stock Markets Crash?
Individual investors have a heightened fear about stock market crashes, especially after the markets have gone up a lot. There is a belief that the higher the markets go, the more likely they are to crash. So, is it high prices that cause the stock market’s to move sharply lower or are there other characteristics that we have to watch out for?
A look at past crashes can offer us some answers. Certainly, many crashes have happened after a market has gone up a lot. The bursting of the technology bubble in 2000 was a good example of this. Stocks had moved irrationally higher and then fell for the next two and a half years. Prior to the crash that came with the financial crisis in 2008, the market had been in an upward trend for 5 years. The Covid pandemic market crash in 2020 came The Covid pandemic market crash in 2020 came after the market had moved up 400% from the post financial crisis lows. Therefore, it does seem that lofty prices in stocks often comes before a market crash.
However, what should stand out from the past 20+ years is that major market crashes do not happen that often, just three occurrences in that time span. Along the way, there were many months and even years of lofty prices that did not bring a crash. Investors who sold or bet against the market just because it had gone up a lot were likely given losses or at least a lot of missed opportunity.
The bursting of the tech bubble came on the heels of extremely irrational prices, a true speculative bubble. The financial crisis came on the surprise of an overly leveraged real estate market. Last year’s crash came on the surprise of the COVID pandemic. Twice, it was a surprise that most people did not consider and once, it was irrational pricing.
Irrational pricing is pretty easy to see (the upward trend goes parabolic on very high volume) but I have found that markets can be irrational a long time before a correction. Surprise, by their nature, are not easy to predict. This leaves us without a simple formula for predicting a crash.
But wait, there is a very simple to predict crashes and avoid the worst of their damage.
All crashes that I have seen started with a sharp break of an upward trend line. There was no need to be an expert on markets or to have any great insight. The market itself is the expert with large amounts of money managed by very smart people with great insight. All we, as individual investors, must do is follow what the big money is doing. When the selling pressure is so strong that it breaks an upward trend line, sell and get ready for the opportunity that the crash will bring. That requires a pencil and a ruler, nothing more.
That is the most important thing about market crashes. They are like forest fires, allowing for new growth and a market that is healthier than before. Consider what the stock market has done since the COVID crash – straight up!
Here is what you should do each week.
- Go to Stockscores.com
- In the upper left, beside the box that says, “Get the Stockscores”, type in the symbol SPY. This will give you a chart of the S&P 500.
- Click on the 3y above the chart, that will make it a 3-year weekly chart
- Inspect the chart to see if a line drawn across the bottoms has been penetrated.
- If it has, lower prices may be coming
Alternatively, watch my weekly Market Minutes video on YouTube. I do this exercise every week for you.
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