Anatomy of a Crash

By: The Phony Prognosticator

© 2000 All Rights Reserved

Many of the regular visitors to this website have seen reference graphs from my proprietary stock market model. One may ask how this model is affected when a market crash occurs. Let's take a quick look at how it functions during the 1987 market crash and how money could have been made (or not lost) by using it.

Refer to the graph of the signal from the proprietary model below. The signal indicates that the investor is in a buy position for almost three months throughout the summer. Then it gives a clear and unequivocal signal to sell by being frozen for several weeks all the way up to the point when prices plunge over the cliff.

crash1.gif (8494 bytes)

An investor following this signal would make make money during the 1987 crash even though the model provides an alert several weeks before the actual event. This early signal to sell (just before the final bubble--if you call that early) does not provide the maximum realizable profit from the investment, but would have saved the investor from a substantial loss occurring several weeks later.

From time to time it is good to remind oneself what an actual crash looks like. It then becomes easy to put normal market upturns and downturns into perspective. Many investors today are abnormally concerned when the market declines several hundred points, not realizing that on a percentage basis, the decline is actually quite small.

Why is looking at the relationship between the moving averages and the Relative Strength Indicators important? Prior to the crash, the longer moving averages begin to cross over the shorter ones as prices begin to fall. The prices and moving averages begin to look like water going over Niagara Falls as they continue to drop. At this point, how valid does the Relative Strength Indicator become? Refer to the graph below.

crash2.gif (16387 bytes)

Examine the chart closely to see that RSI gave a strong signal -- well before the plunge of prices into an almost bottomless pit. The sell signals are indicated by ovals and the rectangles indicate buy signals. As you can see, these are all valid signals based on what the market actually did. Two or three strong signals before a crash are common, and this is what occurred. The final signal is very strong.


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