Today I’m going to shed some light on to why market crashes are not rare as is commonly assumed by most, but actually an event taking place everyday in markets all over the world.
This may be hard to believe, as usually when markets crash its all over the news, the reason the crashes happening today or tomorrow are never reported are because their not affecting a significant portion of people. The 2008 financial crisis affected everyone, business, traders, housing markets, compare this with the crash you may see tomorrow which is only going to affect a few traders then it’s easy to see why you never hear about them.
I think everyone who’s reading this will of at least lived through one market crash. the most recent one on a world scale would be the global financial crisis back in 2008, although this was a really big crash there have been events since then which would also constitute to a market crash.
2014 saw the complete collapse of the CHF, this crash was quite different to other market crashes due to the speed at which it happened.
If you look at a chart of any currency cross with CHF in it you’ll see how quickly the markets declined.
In 15 minutes all CHF currency crosses suffered enormous drops, USD/CHF went down 1833 pips ! An unprecedented decline !
What Causes Market Crashes ?
George Soros has this to say about market crashes.
“Stock market bubbles don’t grow out of thin air. They have a solid basis in reality, but reality as distorted by a misconception.”
Soros is explaining how crashes in the stock markets always begin with a fundamental reason as to why they should go up, people believe this to be a good reason for the markets to rise as on the surface it makes sense, unfortunately this fundamental reason is actually a misconception.
The perfect example of a crash caused by a clear misconception was the dot-com bubble back in the late 1990’s.
The dot-com bubble was caused by the rapid growth of the internet, a slew of internet based business start-ups were created in order to take advantage of the new possibilities offered by the expansion of the internet.
Alot of these companies began adding .com or E prefixes to their business name to make it look like they were a valid internet company, this caused people to invest as they identified it as being the hot new thing. The misconception was that these companies were for the future and the incredible rise in the stock prices of these companies duped investors into overlooking the typical metrics used for company evaluation. Things like profits and earnings ratio were neglected, and investors started buying shares in these companies because of the technological advancements they thought they would make in the future.
This is what Soros is saying in his quote.
The fundamental reason which people caused people to start investing in these companies was the idea that the companies would be very important in the future due to the rapid growth of the internet. This is an entirely logical conclusion to come to. Unfortunately, the misconception was because these companies and the internet were new at the time, it caused investors to overlook the usual analysis they would’ve undertaken to determine if a company had any chance of achieving substantial profitability in the future.
Investors were buying stock in companies which had never made a profit in their history !
Eventually the bubble burst, the prices of the stocks had risen to such an extent that the market could not sustain itself any longer, when it was found that most of the companies people had invested in were not even making any profits, the markets dropped dramatically. Within two years over 5 billion dollars had been wiped off the share price of the NASDAQ, very few of the initial startups survived the aftermath. A few however did, at the height of the bubble the share price of Amazon reached $100 ! When the crash began it hit a low of $7 per share, fortunately it was one of the few business that managed to recover, nowadays a share in amazon will set you back around $500.
Everyday Occurrence ?
Most people are under the impression that market crashes are rare, they believe crashes only happen every few years or even every decade I’m going to let you in on a small secret, market crashes happen every single day, there’s probably one occurring right now ! you’ll never hear anyone talk about them though.
Not because there not happening but because most people don’t know there happening.
Lets take a look at a chart of a crash.
The image above is a chart of the down move on GBP/USD during the 2008 financial crisis ( keep in mind this is on the weekly chart) I want you to look at the structure of this crash for a minute.
Notice how there’s an initial drop followed by a consolidation, (that lasts for roughly a month and half ) which then develops into an even more significant drop, at this point the crash is in full swing. All the economic news is bad, the people in the media are saying how things are really bad, all of this negative information creates an unprecedented amount of fear in the market which leads everyone to begin selling.
Now I want you look at this image.
What time frame do you I took this picture on ?
Nope, this is taken from a 1 hour chart of USD/JPY on the 1st of September 2015
Notice how similar both charts look. Certain sections of market structure are present in both images, the initial drop which turns into a consolidation which is followed by a significant down move.
To understand why the structure of charts is so similar yet were taken on completely different time frames and different currencies requires an understanding of the psychology of the traders who have placed trades on the up-move before the first drop.
When the market is in a trend the length of the trend has a direct effect on the psychology of the traders, the longer the trend is, the more people will believe its going to continue. Before markets crash there’s usually been a prolonged up-trend in place, the mindset of the traders who are long in the up-trend is one of the market continuing to move higher indefinitely, they expect the market to keep going up because of how long the up-trend has been in place.
When it comes down to it the psychology of the traders present in both crashes are the same, both of these down moves are market crashes only the one we see on the 1 hour chart affected a much smaller amount of people so there’s never any need for the media to report it.
The emotions of people who were buy positions when the markets crashed in 2008 are the same as the emotions traders felt by traders when the market fell in the second example on USD/JPY. Their reactions are the same, the market starts to fall and they get scared of losing money, meaning they close their trades. These traders closing their trades makes the market fall even further, which in turn causes even more traders who may have been long on the up move to close their trades, as if that wasn’t enough, on top of this there will be traders placing sell trades just because they see the market falling.
At the end of the day fear and greed are same.
Whether it’s happening to 200 people or 20,000, when people are put in a situation where they are scared of something happening they will take action. Groups of people will always react in the same way, if the market suddenly moves up after being in a massive down-trend people who were short will start closing their trades because their scared of losing money ! This is what happens in both examples. In 2008 we had a situation where lots and lots of people were long expecting the market to continue higher, on the USD/JPY example we had far less traders who were long but reacted in the same way when the market began to fall against their positions.
Market crashes are only ever heard or talked about when their affecting a significant amount of people, if a crash occurs on a world scale everyone’s going to know about it as its considered big news, a crash occurring tomorrow is never going to be reported, who cares about the 5000 traders who lost money when the market fell, that’s not big news !
In a few days I’ll be releasing an article in which I’ll detail a trading method you can use to take advantage of market crashes. This method, whilst be highly unorthodox is a strategy which, if implemented properly, will allow you to make alot of money without actually being put in danger of losing money.