How to Know When a Correction in the Market is Approaching – Introduction
Trading in the financial market is one of the most interesting things you can do. This is mostly because of the number of market forces that affect the movements of the financial assets. Every day, new information is released in the market that ends up affecting the markets. For example, today, investors might be worried about inflation while tomorrow, they will be excited about jobs numbers. In other words, no single day is usually similar to another one.
In several occasions, a market rally can lead to a market crash. To investors, the fear of market crashes is usually real. This is because they tend to lose money when this happens. On the other hand, for traders, a market crash is usually not all that problematic. This is because they are usually flexible about exiting their positions when things start to change.
As a trader, how do you know when a market correction is about to happen?
The first thing you need to look at is the VIX index. This is an index created by the Chicago Board Options Exchange and Goldman Sachs. The index is used by traders to gauge the amount of fear among traders in the market. A rising VIX is usually an indication that the market could see some huge movements, mostly in the downside.
The second thing you need to look at is the reaction from the market participants. Traders and investors tend to follow the money. They tend to buy when everyone is buying and selling when everyone is selling. This is known as the psychology of trading. Therefore, when you see a strong downside movement coupled with increasing volumes, it could be an indication to start selling. As I have written before, volume is often the most important thing that many novice traders ignore.
Next, you should look at the oscillator indicators. These are indicators like the Relative Strength Index, Stochastic, Bulls and Bears Power among others. These indicators help traders know when the financial instruments are overbought or oversold. When assets are overbought, it means that traders could start taking profits which could push the prices lower. The RSI is the most commonly used indicator in this.
Another way to know when a crash is coming is to look at the earnings of major companies. During the earning season, traders watch out for key financial data such as revenue and growth. When certain important companies report weaker finances, the implications could be major. For example, the crash of 2008/9 happened partly because of the financial difficulties facing Lehman Brothers. When this happened, traders thought that other financial companies would face such problems.
As I mentioned above, the fact that you are a trader is better for you. This is because unlike long-term investors you don’t have any obligation to keep holding a losing trade. You can exit a long trade and initiate a short trade and benefit as the price comes down.
Still, it is usually very difficult to predict when a crash is coming. However, you can use these strategies to help you make informed decisions and anticipate a crash.