Market crashes have been happening since markets existed. Over the years, there are many key indicators that flash warning signs—signals that can help people prepare for a potential crash and, in some cases, even profit from it.
Some of the main things I’ve noticed over the years are as follows:
- Liquidity Starts Tightening
This happens when the money dries up. One of the biggest market crash catalysts is when the Federal Reserve or the government takes action to restrict liquidity. Essentially, money flows less abundantly through the financial system.
What causes that?
- The Federal Reserve raising interest rates, which makes borrowing more expensive.
- The Fed reducing its balance sheet, which pulls money out of the system.
- The government cutting spending or raising taxes, which means less stimulus for consumers and businesses.
You can quickly see how that could impact people like you or me.
Let’s look at a recent example: At the end of 2021, the Federal Reserve stopped printing money—almost exactly when the S&P 500 peaked. From that top, the market fell 27%, with even worse losses in tech stocks.
- Euphoria and FOMO
This is when everyone thinks they’re a genius. You hop in an Uber, and the driver starts telling you how much money he’s made off a particular stock. Everyone is talking about it.
Market crashes don’t happen in fear. In fact, they happen during excitement. People believe prices can only go up and ignore the risks involved with investing in financial markets. This leads to FOMO—fear of missing out—and people chasing overextended trends.
Examples?
- The NFT mania, where monkey JPEGs were selling for millions before collapsing.
- The 2006–2008 housing bubble, where people were overleveraged, assuming housing prices would rise forever.
- The 1999–2000 dot-com bubble, where investors threw money into internet stocks with no profits—just ideas.
A simple tool to track this sentiment is the Fear and Greed Index, which gives you a sense of market psychology and whether investors are being too optimistic or cautious.
- “Idiot Money” Starts Circulating
This is when people with little to no investing knowledge start making millions and flexing their profits. It may sound cliché, but it’s real.
You’ll see Discord servers, Telegram chats, and group threads pop up where people start hyping trades and flexing gains. This pulls in more everyday people, which sends these overhyped assets even higher—until they crash.
Think meme stocks and coins like GameStop or Dogecoin. While many got rich, even more lost everything because they never sold. (And yes, I’ve been a victim of this too. That’s why I make these videos—to help others avoid those same mistakes.)
To avoid falling victim, make sure anything you’re invested in has real fundamental backing.
- Illogical Valuations
This might be the most important warning sign of a potential crash.
Before a crash, stock prices often detach from reality. They start trading at valuations that can’t be justified by earnings. This looks like companies making very little profit but holding sky-high valuations.
In the tech bubbles, people believed “this time is different.” A recent example? The AI stock surge of 2024.
Let me show you what I mean: PLTR vs. AMD.
Looking at their PE ratios—PLTR was at 599, while AMD was at 10. Yet AMD was valued at $180 billion and PLTR at $267 billion, despite AMD making more money.
So how does a less profitable company get a higher valuation? Euphoria. Valuations like that are easy to spot—just check the PE ratios.
So, What Can You Do?
When you start seeing these signs and want to prepare, here are two main steps you can take:
- Use a Market-Neutral Strategy
This gives you a way to perform whether we stay in a bull run or enter a bear market. That’s what I’ve been doing with my machine learning trading software. In February, while most assets were down, it made me over 5%.
If you don’t have a market-neutral strategy, that’s the first thing I’d focus on.
- Take Profits and Move to Cash
Taking profits and holding cash gives you “dry powder” to reinvest if markets roll over. When asset prices drop, you can enter with larger positions.
But keep in mind the risk: If the market continues higher while you’re in cash, you’ll have to re-enter at higher prices—meaning smaller positions and lower returns.
While moving to cash can be effective if you’re right, it still carries risk. Fortunately, it’s easier than ever to find market-neutral strategies in today’s investing landscape. In fact, if you check the description, you’ll find links to some of the ones I use.
Make sure to subscribe so you know exactly what to do when the next crash comes.
Peace.
