The simple answer is there are no definitive signs of a pending stock-market crash, otherwise everybody would sell up and leave the market! This may sound a little obvious but it is true. If you look back in history the voices suggesting a pending stock-market crash will more often than not be drowned out by those who kept on pushing prices higher and higher. This is best described as the ultimate bull market.
When pessimists turn positive
One of the more common characteristics of a market which may be ready for a “correction”, or even a crash, is when the most pessimistic analysts/investors begin to turn positive. When there are people positive and those negative on the short, medium and long-term outlook for stock markets, this gives a balanced approach to share price ratings. When everybody turns positive or everybody turns negative than this balance is removed.
There are some analysts who are able to withdraw themselves from the emotion of a bull market/or a bear market, and look at cold hard facts. This would not necessarily predict when a stock market crash might occur but it may well give you an idea of when stock markets are moving into overvalued, or undervalued, territory. However, there is enormous pressure on analysts to deliver returns for their customers which can sometimes cloud their judgement.
Admitting defeat
If we look at a particular stock market or a particular stock there will likely be analysts with a positive outlook and those with a negative outlook at any one time. The problem is that where for example some analysts are negative on a particular stock and the stock continues rising, what do they do? Do they stick with their original recommendation, and watch their clients losing out on further upside, or do they go with the flow, ignore their personal opinion and switch to a buy?
It may seem strange but there is enormous pressure on analyst to go with the flow and what you will tend to find is that once the most pessimistic of analysts have turned positive, the markets may well be approaching the top. We have seen analysts in the past who have recommended relatively large cash holdings for their investors as they were concerned about markets. However, for whatever reason, if the markets rise then they will be delivering submarket returns for their clients. At some point, they will likely be dragged towards a more positive outlook and suddenly everybody is pulling in the same direction. This is a classic overbought scenario.
Are you follow or a leader?
There are followers and leaders in every area of life, people who have the conviction of their own opinions and those who simply follow the crowd. When it comes to stock market investment there is no right or wrong approach to these options because both can potentially make significant returns. We have momentum buyers who will latch onto relatively strong stocks for a relatively short term ride and then bank a profit.
We have leaders who will buy stocks which are oversold and undervalued with perhaps a medium to long term outlook. If their forecasts and calculations are correct then they can easily bank a significant return when the stock becomes “flavour of the day” again. They may need to sit on their investments for a short while until the rest of the market sees what they see. There may be situations where the shares fall even further. This is where you need to have the courage of your convictions. However, if the situation was to change you also need to have the presence of mind to admit defeat, take a loss and move on.
This all sounds very easy in principle but in practice it can be very different!