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How to Avoid a Stock Market Crash Like 1987 Or 1929

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  • How to Avoid a Stock Market Crash Like 1987 Or 1929

    If there is anything that strikes fear into the hearts of stock market investors, it is a major stock market crash.

    Tales have been told of investors going bust, of the savings of an entire generation disappearing, and how it happened quickly and without warning. But is this true? Was there really no warning of an impending stock market crash? In this article I am going to show that there were warning signs, and how you can avoid future crashes.

    The simple fact is, in both major stock market crashes like 1987 or 1929, there are a few clues we have that will alert us to a crash in today's market.

    The first is that prices started falling weeks before the actual stock market crash occurred. In the case of 1987, a full seven weeks of lower prices from the previous high happened. In 1929 it was also seven weeks from the previous peak.

    Number two is the fact that between this seven week period, prices bounced. What does this mean? Prices fell from the peak, then rose for one to three weeks before falling again - this time through the previous trough in price. In both cases the very next week was the week of the stock market crash.

    If we look at this particular movement on a price chart, it will look like a downwards zig zag. And it was so prominent that Charles Dow wrote about it intensively in the late 1800s - making it his own as it is called today: "Dow Theory".

    Pretty simple so far, isn't it? But there is one caveat - I know what you're going to ask. Will a stock market crash happen every time we see a downwards zig zag? Unfortunately not. If it crashed every time, we would have seen dozens over the last hundred years.

    But Dow Theory isn't just good at finding possible crashes - it warns of bear markets and recessions too. In fact in late 2007 well before the "experts" were talking about bear markets or recessions, you will see that same little zig zag down, giving fair warning to us all. It can be severe like 1987 or 1929, it could be slow and drawn out like 2008, or it might just reverse and go back up again.

    Overall, the probability is high though, at around 70%.

    So how can you use this? It's easy. As an investor if you see price fall, then bounce, and then fall through the previous trough in price (this can be seen easily on a weekly price chart), then it might be a good time to lighten your portfolio and be ready. After all, if it doesn't happen you can always get back in.

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