Key Indicators of Market Crashes

Understanding the signs that appear before a market crash can help with preparation and potential profit. There are four main indicators that are commonly seen before a crash occurs.

1. Euphoria / Fear of Missing Out (FOMO)

• Bull Markets and Euphoria:
  • Bull markets don’t simply end due to age but die from euphoria.
  • Example: NFTs skyrocketing in price led to fear of missing out, which resulted in a crash.
  • Example: Real estate frenzy before the Great Financial Crisis.
• Identifying Euphoria:
  • Fear and Greed Index: Look up CNN's Fear and Greed Index.
  • Monitor social media (Wall Street Bets, TikTok, Twitter).
  • Personal signs, e.g., family members showing sudden interest in investing.

2. Illogical Valuations

• Unsustainable Profitability:
  • Assets priced with no realistic path to profitability.
  • Example: Dot-com bubble – companies like pets.com.
  • Example: Current potential AI bubble with companies like Palantir.
• Comparing Valuations:
  • Compare price-to-earnings ratios and market caps to gauge valuations.
  • Large expectation gaps in future growth that seem unrealistic can signal a crash.

3. Changes in Monetary/Fiscal Policy

• Liquidity Restriction:
  • Actions by Federal Reserve or government that remove liquidity can signal an impending crash.
  • Example: Federal Reserve’s shift in 2021 led to market declines.
• M2 Money Supply:
  • Monitor money supply as an indicator of liquidity changes.
  • Pay attention to signals of future policy changes by the Fed or government.

4. Inexperienced Individuals Getting Rich

• Sudden Wealth:
  • People with little financial knowledge getting rich quickly and sharing advice.
  • Uber driver or dentist test: Random advice from non-experts is a potential red flag.

Current Market Assessment

• Fear and Greed Index:
  • Currently indicates fear, not widespread euphoria.
• Valuations:
  • Some sectors like AI may have extreme valuations but market-wide not overvalued.
• Fiscal and Monetary Policy:
  • Current policies don’t suggest a severe liquidity restriction.
• Idiots Getting Rich:
  • Not a widespread phenomenon currently.

Strategies for Portfolio Protection

• Trailing Stops:
  • Sell orders that limit potential loss by following the position upwards.
• Out-of-the-Money Puts:
  • Options contracts as a hedge against significant drops.
• Taking Profits:
  • Sell some shares to keep cash ready for buying opportunities.

Conclusion

• The four key indicators of a market crash are not widely present at the moment.
• Continually monitor market conditions and adjust strategies as needed.
• Consider expert advice and trade ideas for asymmetric opportunities.