Predicting Stock Market Bubbles and Crashes

Some professors at Harvard concluded that it is possible to anticipate which of those rises in stock market sectors will burst and lead to a crash. After studying a lot of bubbles and crashes and running the data through computers, they concluded that there are common characteristics in stock market crashes. Even so, their tools aren’t precise and won’t help you time markets precisely. But it’s a better method than following a sector all the way up and back down.

While the Harvard authors found that much of Fama’s view is correct, especially that sharp run-ups in shares aren’t by themselves progenitors of market meltdowns, they say tools exist for bailing from the rallies most likely to end violently. Keeping out of crashes can add 10 percentage points to an investor’s long-term return, they said.

“When investors look at a very large price runup in an industry and they are concerned if there is a potential bubble, they should look at some of the other non-price features and behavior as a guide to what might happen,” Greenwood said by phone . “People who have studied bubbles have been solely focused on the price action. We wanted to have a serious attempt to bring in some other information.”