Indicators That Help in Predicting Stock Market Crashes

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The stock market tends to run in cycles and some of these indicators

1) Rampant Speculation: The first step towards the downfall is when speculation becomes rampant. This rampant speculation ensures that a positive feedback loop is prevalent in the market. Hence, the stocks are driven higher than their true value. As a result, a bubble is created. Current high prices become the reason for expecting future hikes in prices.

2) Low Growth Rates: A slowdown in the overall economic growth is a significant indicator that the stock market is going to crash. A slowdown, by itself, does not mean that the market will collapse. However, rampant speculation and slowdown in the growth rate are a potent combination.

3) Peak Valuations: The valuation of stocks is often at its peak just before a market slowdown. For instance, if historical records show that the average stock has traded at 15 times EBIT and at the present moment the same stock is trading at 27 times EBIT, then the valuations are stretched.

4) Low-Interest Rates: The root cause of any kind of bubble is the presence of too much money in the market. When central banks lower interest rates, they incentivize banks to create more money by the fractional reserve lending process. This process has almost always led to a bubble and crash in the long term.