Sol Palha: Financial & Economic Insights History of Stock Market Crashes; Buy The Fear & Sell The Noise

History of Stock Market Crashes; Buy The Fear & Sell The Noise

History of Stock Market Crashes;

Patience is power; with time and patience, the mulberry leaf becomes a silk gown.

Chinese Proverbs, Sayings of Chinese Origin

History of Stock Market Crashes; Illustrates that Fear never pays Off

The following content has been extracted from the Feb 2, 2010, Market update that was sent out to subscribers.

While the data might seem timeworn, the main point to walk away with is that history repeats itself. When it comes to the markets there is no such as thing as old patterns; there are only old fools who continue to dance to the same beat hoping for a different outcome.  Mass Psychology states that the best time to buy is when the masses are panicking and the best time to sell is when they are Euphoric.

If you combine mass psychology with simple common sense data, some of which is discussed below, you have an above-average chance of winning in the markets. Any serious student of the markets will state that study of the history of stock market crashes, clearly illustrates that one would have made a fortune if one purchased top quality companies during the crash phase.


20 day moving average of new lows = 4615 (New record set on Sept 16th, 2008).

One year moving average of new highs = 10 (New all-time low set on Nov 25th, 2008)

One year moving average of new lows= 2225 (New all-time Recordset on Sept 16, 2008)

The number of new highs has moved up slightly

History of stock market crashes shows that you should never follow the crowd

But the 20 days moving average of new lows is still leading Although the market has mounted an adamant rally over the past two days. Another revealing factor is that the 100 days and one year moving an average of new lows are virtually unchanged from last week’s numbers. This action clearly indicates that all is not well in the markets as the internal structure is weakening.

In one week the Dow was able to take out 10400, and 10200 and the interesting part is that both price points were taken out on volume of over 7 billion shares. If the Dow remains below 10,200 today, it will have traded below 10,200 for three days and will now issue a stronger signal that it is ready to mount a decent to steep correction. The break below 10,200 is significant for it was the bottom of a channel formation that took shape from Nov 2009. A break below a channel formation, especially when the markets are extremely overbought usually produces a strong move in the downward direction. Market update Jan 26, 2010.

Trends are determined by key Support and Resistance points

Trends are determined by key Support and Resistance points

The Dow traded as low as 10050 and Dow futures traded as low as 9994 and then bounced back very strongly. The break below 10,200 turned the trend negative, but the Dow needs to stay below this level. Trends are determined by key price points, and for a trend to remain valid, the market must remain below that price point. Thus if the Dow trades past 10,200 for three days in a row, it will neutralise the previous signal.

It will not, however, negate the fact that breaking below a channel formation after a strong run-up usually produces a strong downward move; it will only delay the action. We have further signs that all is not well in the markets. MMM a stock that rallied strongly with Dow closed lower on Monday, and today it closed unchanged; in the past two days, the Dow has tacked on over 200 points. If you look at the banking sector, many former higher flyers are also not performing all that well.

Correction or Crash 

The Dow dropped from 10729 to 10000 in a very short period; the intensity of this pullback was extreme. The markets had not experienced anything like this since March of last year. Thus this pullback has fooled many players to adopt the old strategy of buying on the dip. We also have a large group of traders that sat out of the market for a very long time, and they probably view this large pull back (large only because it took place so fast) as a buying opportunity. This is more like a trap than a buying opportunity.

The safest position is to be on the sidelines until a very strong sell signal, or another buy signal is generated. To let out enough steam and move the risk to reward ratio in our favour, the Dow would have to at the minimum shed 1500-1800 points, and so far it barely shed 700 points.

Low Volume is usually not a good sign

Low Volume is usually not a good sign

Despite the strong rally, the Dow has mounted in the last two days; the volume has not even hit the 6 billion mark; on Monday volume barely hit the 4.7 billion share mark, and today it came in at 5.47 billion. On the 21st and 22nd of January when the market sold off, volume spiked on both days and surged past the 7 billion mark. If you need one thing and one thing only to remind you of the very dangerous structure of this market then remember this.

The Dow put in 22 new highs (this is a huge number) in a period of just a few months and not even once did the volume surge to the 6.8 billion mark let alone the 7 billion mark. When the market sold off, for two consecutive days in a row, the volume surged over 7 billion shares. Remember this for it is a very important development. Long term the market is clearly treading on a very shaky ground.

We would like subscribers to remember just how fast the Dow dropped from 10729 to 10050; this is just the prelude of what lies in store. If the markets should surge to test their old highs or maybe even put in, new highs do not let this move up fool you. Pay attention to the volume and the divergences.

Dow utilities breaking down

The Dow utilities broke down one month before the markets, and so they appear to have resumed their leadership role. If the Dow should rally to new highs, a failure by the utilities to match them and surge to new highs before the Dow would be another clear signal that the markets are heading into a danger zone. Copper another leading economic indicator is trading well off its highs, and the Baltic Dry index has put in a double top formation.

If the Dow rallies to test its old highs without pulling back to the 9200-9400 ranges, then it will be setting itself up for an extreme correction. This rapid move down was simply not enough to let out all the steam this market has built up and a strong rally now will result in a step similar to one that took place in the bond markets between Dec 2008 and July 2009. Bonds shed over 20% in 6 months, for bonds this is a massive move, so for stocks, a comparable move would be in the 40% plus ranges.

Volatility levels are surgings

Volatility readings have surged to yet another new high indicating that powerful moves are going to continue to plague this market. Look how fast this market pulled back, and it reversed course just as fast. The moves though have still been one-sided in nature (mostly to the upside) for the most part, but the next move will be for the majority of the swings to occur on the downside.

Finally, if the current daily sell is neutralised and a buy signal is issued on the daily charts, we will send out an interim update as it could be an early signal that the Dow is going to re-test its old highs. Right now we still have a daily sell signal, in effect; the weekly while closer to the sell zone has not generated a sell signal yet.

History of Stock Market Crashes & Investing

If you take the very short-term view, you are going to get frustrated with the concepts of patience and discipline, but understand that one needs to look further out and check to see if everything is clear before jumping in. Significant gains are not made by taking the very short-term view. For several months in a row, we stated that Palladium was an incredible buy (several times we went out and called it a screaming buy) and from Oct 2008 to March of 2009 it did virtually nothing. Short term traders were bored by this talk, but those that waited and held did very well.

The same can be said for the markets; we spoke of the markets putting a bottom, well in advance of them putting in the final bottom. In fact, when we issued our targets for Dow 10,500 in Feb 2009; at that time the market was taking a beating, and we looked like bloody fools for stating that it was going to rally to the 10,500 ranges eventually.

We have run into this same situation over and over, and from each encounter, we have discovered the same principle always applies. Those who have no patience or discipline end up giving up all their gains and then some. If looks at the history of stock market crashes, one finds that the best time to buy is when the masses are panicking. Experts will spin another tale and indicate that the history of stock market crashes paints a different picture. However, if one was a perma bear one would have lost their entire fortune for the markets always trend upwards.

Do not join this crowd for they are always looking for new members.

The daily trend is still down, and all long-term indicators are clearly stating that the risk to reward ratio is not in our favour when it comes to opening up long positions. Only very short-term indicators are giving off some bullish readings and these indicators change direction very fast. We got a small taste of how fast the markets can move downwards when the selling started. The Dow has been trying to trade to the 10700 ranges since Nov 2009, but in just a few days the Dow dropped from 10700 back to its Nov 2009 levels. It took a few days to drive the markets back to the starting point.

Market internals not so healthy

Market internals is also suggesting all is not well in the markets going forward as is the volume. Therefore, despite the urge to jump into the markets, we urge long-term investors to sit on the sidelines and maybe ease into a few put positions as a hedge. Once a full-fledged/Strong sell signal is generated you can start to purchase puts more aggressively.

Quantifying Signals

A full-fledged sell is a sell signal from our smart money indicator. A very strong sell signal would be a sell signal generated on the weekly time frames. Right now we have a daily sell signal, in effect, only, so we are not going to act aggressively on it.

Looking further down the line (7-12 months ahead) there are going to be many opportunities in the commodity’s sector as the world’s central governments are going to continue to destroy their currencies. Furthermore, supplies of many key commodities are declining across the board. The precious metals sector is certainly going to shine strongly over the long-term as central bankers are creating new money at a mind-numbing rate. Many countries will have to restrict their mining activities because of electricity shortages; this is yet another factor that will come to play when the dust finally settles down. However, don’t forget what we stated before, the history of stock market crashes indicates that the astute investor would do well to buy the fear and sell the noise.

Commodities gearing up for a strong rally?

There are so many overwhelming reasons to support an adamant sustained rally in the commodities sector (especially in the Energy and Precious Metals sub-sectors) that we would have to write a whole article just to cover them; however, when it comes to the general markets there is very little to support a long-term rally. In fact, one would have to push one’s imagination in an attempt to find evidence that supports a long rally in the markets; at least for now, but the future could change. The saying doesn’t fight the feds was not invented for no reason. So if the Feds remain aggressive, then the market could rally much higher even though the fundamentals and technical might not support a rally.

We still see more upside in Gold, but given the early signs of strength in the dollar (via our indicators), we suspect that Gold could put in a multi-year top before it resumes its upward trend.  The dollar also appears ready to rally much higher, and the Dow could rally much higher if the Fed continues its aggressive stance.  Flooding the market with money is the fastest way to prop the markets up. Thus patience is warranted for many sectors that have rallied since March 09 are rotten to the core and will crumble once reality sets in.

An ounce of patience is worth a pound of brains.

Dutch Proverbs, Sayings of Dutch Origin

Other Articles:

Technical Analysis

Mass Psychology Introduction

Portfolio Management Suggestions

The Good And the Ugly On Trading Futures

Ultimate Timing Indicator

Esoteric Cycles

Introduction to Mass Psychology

Crowd Psychology and Markets

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