For the past century, the stock market has been the foundation of our economic advancement and a source of financial support for many of the well-known companies today.
Coca-Cola, for instance, started in the year 1923 have built its brand from a 25 Million dollar company into today’s 234.63 Billion dollar company.
The stock market has made it possible. And investors who have invested in such companies have made millions and become rich beyond their imagination.
Will The Stock Market Always Go Up?
The stock market will not grow “forever”. The stock market can go up over time due to inflation, retained earnings, increase in productivity. The stock market is a positive-sum game since it is mainly driven by the profits earned by the companies.
“What goes up, must come down.”
Throughout history, there are many ups and downs in the stock market.
In fact, there were a few times the stock market wipe out more than 10% of the equity in the stock market in just one single day.
This drop caused major panic that cause the market to fall even further by 50%, or more lasted for months, or even years before the recovery of the stock market.
What is the worst stock market crash in history?
The worst stock market crash is in 1929, the catalyst of the “Great Depression” and is more commonly known as the “Black Monday” and “Black Tuesday”. The market dived by 25% in just 2 days, and by mid-November of that year, the stock market lost half its value.
Finally, after 3 years in 1932, the market collapse hit rock bottom.
At that time, the Dow Jones Industrial Average is recorded to have lost a staggering 90 percent, and thousands of companies have closed down with millions being unemployed in the streets.
Recent Stock Market Crash
- 1987 – Black Monday, program trading that crashes the stock market by more than 20% in just one day
- 1990 – Recession, fluctuation of oil prices that cause the market to drop 18% in 3 months
- 1997 – Asian financial Crisis, overheat of the stock market
- 2000 – Dot-com Bubble, the collapse of the technology bubble
- 2008 – Financial Crisis, subprime loans, and credit default swaps
- 2020 – Worldwide Recession, The S&P 500 index dropped 34%, from February 19 to March 23 due to pandemics.
Signs of Stock Market Crash
There are always warning Signs before most market crashes.
If you are able to identify them and prepare for the worst, you might actually survive the market crash or even profit from it.
Can you see the stock market crash patterns?
Here are the Top Warning Signs that may signal a Market Crash is just around the corner!
1. Rapid Rise
Is it safe to assume you will earn from the stock if the price of the stock keeps rising?
Does it mean you should buy it right now and not lose out on its potential gain?
Well… not exactly.
Some traders buy using the rising trend and buy the stock during the rise. They use complex technical analysis to ‘predict’ the future. Some succeed but many don’t.
As a Retail investor, when the news of the stock finally reaches you, the price of the stock has already factored in the value of the company.
And what you are seeing now, is either overvalued or at a premium price.
This is exceptionally true when the stock price rapidly raise in just a few days.
A rapid rise in the price of the stock, or financial asset can be a warning sign of a sharp down turn in the near future.
We have seen numerous stock market bubbles including; the real estate bubble and the tech bubble formed after the rapid increase in prices of the stock.
The problem with bubbles is that they give rise to panic-selling.
And this ultimately leads to a market crash with a prolonged period of recession and unemployment.
Fear of losing out and greed is the downfall of many retail investors. Those who succeed never let their greed affect their actions.
“We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.”Warren Buffett, Legendary Investor
2. MARGIN DEBT
Humans are greedy, do you agree?
When investors want to invest more money than what they had in their bank, what do they do?
Yup, they borrow.
These investors want to make more money in a short time, thus they borrow to invest.
Often, these are the short-term investor who sees a huge rise in the stock market and doesn’t want to miss the boat.
The lucky ones may succeed, while many don’t.
When you see many investors take on a high degree of margin debt. This is a huge red flag!
“A market place filled with greed, the high levels of margin debt often ends with stock market crashes.”
Be it the US stock market, or the Chinese equities, the problem with margin debt is fear.
As the big boys sell, the markets start to sink and everyone panics trying to exit, which crashes the market even more.
Charlie the Vice President of Berkshire Hathaway and good friend of Warren Buffett the Oracle of Omaha says there are only three ways a smart person can go broke during the CNBC interview:
“Liquor, Ladies and Leverage,”
Read Also: What Type of Value Investor Are You?
An initial public offering (IPO) or stock market launch is a type of public offering in the stock exchange where shares of a company are sold to institutional investors and retail investors.
An IPO helps medium and big businesses to get their financial muscle to grow their company.
With the help of millions of shareholders, who share the vision of the future of the company. An IPO will move the company to the next level of growth.
IPO is all nice and rosy until then the time when ‘every Tom, Dick, and Harry’ starts to apply and get approved for their IPO.
One good example is during the Dot Com Bubble (Tech Bubble) when hundreds of technology companies are listed for IPO.
Companies with no solid balance sheet, or income statement are approved for their IPO listing.
Finally, in the year 2000, the bubble busted and the market crashed.
The Dot Com Bubble has brought down together millions of investors and closed hundreds of technology companies.
A surge in the number of IPOs in any given cycle may indicate a bubble.
A clear warning signal that the stock market is going down, it is when the investors are at the most optimistic.
More IPO occurs when the market is the most optimistic, a time when IPO companies can get the most from the market.
4. Mergers & Acquisition
Companies grow usually in 2 ways:
- Slow: Customers Acquisition
- Fast: Mergers and acquisitions of companies
With access to cheap debt at a close to zero interest rate. Companies often choose to expand their business by the means of mergers and acquisitions with their competitors.
This is a concern when companies start buying up unrelated companies.
Companies often swallow up too much, too soon. They used up a massive amount of cash from their cash reserve. This will create a dangerous situation for the company.
‘Time’ is required for a company to generate revenue and gain cash flow.
But by depleting their cash reserves, companies are vulnerable. Companies can fail and end up in bankruptcy from failed mergers and acquisitions.
An increase in the debt interest rate may also cause the company to fail.
As the company is unable to meet its debt obligations due to the lack of cash flow, these companies are forced to close down.
Mergers and acquisitions of unrelated companies are often a signal of greed and increase risk in the stock market. Warren Buffett says it best:
“Risk comes from not knowing what you’re doing.”
Read Also: REITs Investing Guide: Risk and Benefits
5. Issue Debt
When major multinational companies like ‘FANG’ Facebook, Apple, Netflix, Google, and other corporations issue debts for major stock buybacks. This can be a potential trigger of a stock market crash.
A stock buyback scheme is great for shareholders, but when debt is required to be issued to perform a major stock buyback, things can get nasty.
All debts are borrowed money, and it comes with a certain amount of interest. Debt has to be paid back to those it was loaned from.
A major share buyback scheme with the cash from debt can be a dangerous game. And this is a possible sign of the next crash.
It reduces the company’s cash reserve and its ability to tackle any adversity that the company may meet in the future.
If the company’s cash flow is affected, it can affect its operations and eventually its revenue. This will bring the company into a very dangerous territory of not meeting its debt obligation.
The collapse of one such company will be the trigger of a market crash.
Though not through the reasons of issuing debts for major stock buybacks, the fall of Lehmann Brothers is the perfect example that triggers the financial crisis of 2007 to 2008.
Debt can be good, but it can also be a double edge sword that will wound you in the process. Andrew Ross Sorkin the author of ‘Too Big to Fail’ say it best:
“Debt, we’ve learned, is the match that lights the fire of every crisis. Every crisis has its own set of villains but all require one similar ingredient to create a true crisis: too much leverage.”
Learn more about debt with Andrew Ross and get yourself educated about debt.
Read Also: How to Get Out of Debt Easy
How to Tell If A Market Crash Is Coming?
Fear and Greed are the cause of the most market crash. These are the nature of humans.
In the stock market,
- Greed drives the market price to rise to an unsustainable level.
- Fear drives the market down to an unimaginable level.
We as investors know that investing comes with risk and reward. It is up to us to balance the risk that we may ripe our reward.
Here we are able to learn some of the most important warning signals that the stock market shows us before the market crash happens.
Warning Signs of Stock Market Crash
- Rapid Rise
- Margin Debt
- Increase IPO
- Merger and Acquisition
- Issue Debt
Signs of a Stock Market crash are many, it is up to us to see them and to prepare ourselves for the stock market crash.
And if you are seeing 2 more signs of the market crash. I will advise being very careful at what you are investing, and probably rebalance your portfolio if required.
Question: “Is the Market showing the signs of a stock market crash right now?”
“Risk comes from not knowing what you’re doing.”
Wisdom from Billionaire Warren Buffett:
Success is not made overnight, but through determination and the conviction to keep learning and getting better.
Remember the difference between success and failure is what you know, and what actions you take.
Here are some resources that will help in guiding you to your success.
- Investing Books to Riches
- Business Startup Books
- Leadership Books for aspiring Leaders
- Sales Books to Wealth and Success
- Life Changing Books to a Future of Success
What guides me in my journey to financial freedom are some of the many books I read for the past years.
“Invest in yourself is the best investment you can make.”
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