Chapter 3

Being optimistic about the future is mentally healthy, but also watching the current situations leads to better wealth. There are times when the entire market falls down. The most commonly known crashes (for general public) are 1929 and 2008. This chart is courtesy of WallStreetGenius.com and is the Dow Jones Index (top rated stocks) gains and losses.

As you can see there were years that the market lost upto 50% of it's value. That means it would need to gain back 100% just to be equal. This is how ratios work: 1/2 = 50%, but 2/1 is 100% gain.

The crash of 1929 lasted 3 years and led to 90% of the value being lost from the peak. It didn't get back to it's peak value until 1954. Waiting 25 years just to break even is too long for someone that was expecting to retire in 1935.

I was an industry advisor to a central bank, and have studied the works of great economic analysts. The simple driver in most crashes is availability of cash. Also called money market liquidity. There were short crashes for other reasons, but the big ones are simply that there wasn't much money in circulation. If someone needed cash they'd sell their shares. As you can imagine, there are shouting of voices during a panic, "I need to sell," and there were fewer buyers (with cash). The price would drop strongly as desperate sellers would flood the market with their sell orders.

Smaller drops in the market were caused by events like the earthquake in San Francisco (1906 Earthquake details ). Real assets were destroyed and hence the companies value was lowered. The surprising fact about all crashes (including the quake) was it takes a long time for the market to reflect the new lows. A smart investor in 1906 would have sold off their positions in the railroads immediately. It took weeks for the market to acknowledge the asset depreciation. 

Bubbles and Manias

There are times when a market is driven up by too much optimism. The oldest known one is the 1636 Tulip mania. We look back and say "How could they be so stupid? That'll never happen again." Let's consider the Gold Crash 1869, or the dot com bubble. It does happen again and again. It can happens many times a year with individual items: BitCoin, and various share prices (AMD, TASR). Manias still happen because human emotion-based decision making is very active. Most investors don't know they are making the same bad mistakes.

The price of gold was pushed up and then fell. The fall of gold in 2013 was predictable risk in 2012, at $1,800 it was at the top and it was reasonably clear idea to leave at $1,600. Yet there are advisors and "Gold Bugs" that are touting that buying this is a great idea while it's still falling. These people are using emotions and hope and some feeling-based thinking to say it will go up. The price movements don't agree. The price is always accurate..it's not a predictor..it's a truth teller! Predictions can be more accurate than 50/50 if it's backed by some trend indicators. We have trend indicators available to us. Will you be wise enough to use them?

 There is a time to leave the market. A major crash is not good for buy-and-hold strategy.