No one can time the exact moment of a market crash…But there are signs before one happens. PBRG contributor Jason Bodner says institutional selling is one giant red flag. He explains how to spot this sign below…
Market crashes, like anything, have two sides of the coin.
They can be nightmares for many, and opportunities for the few who are prepared. I’ll get into specifics in a moment, but first let’s discuss what typically happens during a crash.
First of all, crashes are often sudden, and especially now with the “flash-crash” moniker fresh on the minds of investors, sudden crashes are expected to be the new norm by many pundits.
The truth is, there is a tale of the tape that—if read properly beforehand—can save investors a lot of frustration, anxiety, and money.
The most obvious tell is when the market fails to break through to new highs, especially after several attempts.
On the surface, everything may seem fine, but there are often stressors under the surface that are hard to spot at the time. Think dot-com in 2000 and real estate in 2008.
Generally, these cracks begin to occur when investor consensus is very bullish on the market. When bullishness reaches extreme levels, eventually the market reaches its “uncle point” and a rush for the exit occurs.
The good news is that there are often hints in the market that can forewarn a potential crash.
The “smart money” is usually first in line to realize something is amiss in the market. The retail investor is rarely the first out. As big institutions with sizeable positions in stocks get internal signals of what they deem to be the top of the market, they try and prepare to sell stocks while the market is strong.
This naturally begins pushing stocks lower. Now, it doesn’t happen all at once, and to the untrained eye, these sell-offs represent a chance to scoop shares up in hopes of the rally resuming.
But when big institutions start dumping stocks, they try not to impact the market so they can get the best prices. They are professional money managers who get paid based on performance, so they are likely not going to announce to the world that they’re exiting stocks until they already have.
But what is the average investor to do?
If you don’t make enough from your trades or you’re unhappy with your income, this is something you’ll really want to check this out…
The key is to keep a sound head. Allowing emotions to take over your decision-making ability is a recipe for disaster. The usual cycle is witnessing price destruction, doing nothing, allowing fear and anxiety to build, and ultimately crying uncle at the worst possible time. It’s classic human behavior and it happens time and time again.
The real question is, “how do I know when to begin reducing risk, taking profits, raising cash, and be prepared to swoop in when the market bottoms out?”
The simple answer from my perspective is to let the institutional investment community tell you.
Think about it: they move in large packs, and their investment actions become a self-fulfilling prophecy. If the exit signs have illuminated for the biggest investors out there, then their moves will spell the top by way of their actions only.
When the dust settles after everyday investors have liquidated their portfolios because they can’t stand losing any more money, is when institutions come in and start buying back. This cycle has happened countless times.
Wouldn’t you rather be on their side of the trade?
My whole focus is to monitor what the “big boys” are doing in an effort to try and understand where they see the opportunities and risks.
Here’s how we look at the market: If signs point to heavy institutional selling, while indices power higher or remain flat, this is a key divergence that sounds alarm bells and makes us take notice.
These are the times to reassess the market situation and have a game plan ready, should equities appear as though they are about to reach a tipping point. When signals of selling are occurring across the board with specific sectors leading the stress, we feel it is prudent to cut that risk out of our portfolio and use that cash when opportunity strikes.
Opportunity can come in many forms, but in the case of a crash—having dry powder ready to take a position when others are selling recklessly is the ultimate goal.
Remember what legendary investor Warren Buffett always says: “Be fearful when others are greedy and greedy when others are fearful.” This is great advice, but buying when there’s blood in the streets is only possible if you have money available to buy with.
In my opinion, picking the ultimate top and bottom is impossible and out of our control. I’ll leave that game for others to play. Keeping a sound head, however, is imperative to being able to make the best out of a scary situation. Part of keeping calm is having a fine-tuned eye on what the market is really telling us, even when it seems like it’s merely a whisper.
Again, we look to big institutional buying and selling activity to tell us when markets are about to power higher or when they are about to get pounded lower.
The current environment supports continued strong stock performance, but being able to realize when things go afoul allows us to position ourselves with a “risk management and opportunity” frame of mind as opposed to one dominated by “fear and dread.”
Because it is counter-intuitive, many might find it easier to buy into an aging bull market and difficult to buy into a painful sell-off. The fact is that all major crashes have preceded long bull markets with higher highs.
It is only possible to take advantage of a crash as an opportunity if you are ready.
We all instinctively know what to do, but the hard part is knowing when to do it.
You can take the guesswork out of it by letting the unusual institutional activity tell us when it’s time.