How to check for market’s pulse

How to check the market’s pulse

Most of the time, the stock market goes up. And suddenly, when you don’t expect it, it falls. Sadly, stock market investors can’t completely predict or avoid periodical slopes or corrections. But short view back at history’s significant stock market drops always can help control your investments going onward. Also, it could give you a suggestion of when a market drop may be in the cards.

What causes a stock market crash?

There is some research into the similarity of stock market crashes. Scott Nations, author of “The History of the United States in Five Crashes,” search the important stock market falls and found that all crashes involve an overvalued market. 

There is always a type of financial engineering or gadget, he called it “contraption” too, as much as an external catalyst, frequently unrelated to the stock market.

Let’s say, the best sign of how the market is being evaluated can be found in its price-to-earnings ratio or PE. We spoke about it before when we learned to value individual stocks. By dividing the aggregate price of the stock market by all of the company’s earnings, you arrive at the price investors will pay for $1 of the company’s earnings or profit. The lower the PE ratio, the cheaper, meaning more undervalued, the stock market.

If we are examining the market’s historical PE ratio and linking it to its today’s ratio, we will get an idea of the stock markets relative value.

Dow Jones chart
market’s historical ratio

The economist John Maynard Keynes, said: “The market can stay irrational longer than you can stay solvent.”

What does it mean?

A stock market can stay overvalued for a long time before it corrects itself. So, examining the market’s historical PE ratio alone isn’t enough to predict when a crash will occur.

You have to know that the catalyst for a stock market crash could be literally anything.

For example, markets closed for six days following the 9/11 attacks in 200. That was an attempt to prevent a market crash. Despite that struggle, on the first trading day after the attacks, the market fell 684 points or 7.1%. That was the largest one-day loss in the history of the stock market.

Other crashes can similarly be connected to crashes. The 1907 stock market crash was caused by the apocalyptic San Francisco earthquake of 1906. Do you remember the 1987 Black Monday crash? It was somewhat influenced by the Iran War.

The truth is, it’s not always simple to understand when a prominent event will cause a market crash. Of course, that doesn’t stop nervous investors from exaggerating to a potential market-moving event.

It’s very important to understand the way the market is trending and to try to predict if a change is coming if you’re going to invest. Traders regularly look for chances through following a trend. Or when the market reverses direction.

Assume you are interested in the art market. Take a look in the chart below. This is the value of sales on the art market with linear trend function over 12 years.

Art market

 

Take a closer look at the year 2009 and then 2010. Do you think there were clear signs of market reversal?

Of course not. 

There are no real trustworthy outspoken signs that will definitely tell you what the market is going to do in the near future. But it would be a total lie to say that you can’t have a sense for coming developments. You can have a good view of future trends by watching the flow of money into and out of the market.

It’s a bit similar to betting. But as you get a deeper view of it, the method becomes more stable. The idea behind it is that if more money is going into the market than it is coming out, you can suppose prices to continue growing. Here we come to the general rules of thumb.

Quiz yourself on market pulses and indicators in the following quiz:

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