Anatomy of a Crash 

When a financial asset bubble bursts, there are various elements that become apparent only after the asset bubble has burst. 

There are usually a slew of reasons why assets are not sold.

The first is the general mood at the peak of the bubbles’ height. Extreme optimism that additional advances are just around the corner is always in evidence and pervasive. 

Typically, the most that anyone is ready to declare publicly is that the risk has increased in some way. 

Because all of the topping signals become incongruent, it is at best questionable when it is time to get out technically. 

Most of the time, the road begins with a breakout to new highs that surpasses the previous resistance. 

At that point, it becomes evident to bulls that this is still a trustworthy indication for further rises in the future. 

The advance does away with traditional technical indications such as double tops and head and shoulders. 

When a breakout occurs that considerably exceeds resistance, traders are given the “all-in” signal to enter the market long. 

Then the initial decrease occurs, and the bulls step in to “buy the dip.”

But the rally fades.

These investors ignore this as an oddity and proceed to purchase the second dip.

That, too, fails, and by the time the third buy-the-dip has failed, many of the buy-the-dippers become disillusioned.

When it becomes evident that buying the three dips has failed, the self-reinforcing cascade of selling starts.

The market begins to crash.

When the dust has settled, the majority who believed in the inescapability of further advances will have been driven from their positions.

A combination of near-term analysis with a larger-picture viewpoint is beneficial in decision-making. 

The center graph depicts the relationship between the amount of money that Rydex investors have put into bullish funds and the amount of money that they have put into bearish funds. 

On the left-hand side of the screen, you’ll see the words “usual range.” 

15 years ago, the ratio was anywhere between 1:1 and 2:1. It was a very even split between the two groups. 

People are normally more optimistic than pessimistic, and as a result, there was a little more money in bull funds than in bear funds in the aggregate. 

During the last five years, investors have gone completely insane. 

On November 19, the ratio reached a record high of 62:1. 

That’s right: There is 62 times as much money in the bullish stock funds at Rydex as there is in the bearish stock funds at the same brokerage. 

Believe it or not, that isn’t even the most bizarre indicator on this graph. Take a look at the graph at the bottom of this page, which shows the ratio of leveraged bullish funds to leveraged bearish funds. 

There is 82 times as much money invested in leveraged bullish funds as there is in leveraged bearish funds, according to the results of the analysis. 

That is incredible. It dwarfs anything in the past.

Relatedly, a Dec. 3 Barron’s headline said:

‘Margin Debt’ Is Rising. It’s Becoming a Risk for Stocks.

On Dec. 20, another Barron’s headline said:

The Good News as Stocks Plunge? Cash Is Pouring Into Equity Funds.

Is this extraordinary increase in optimistic sentiment a portent of a significant stock market reversal?