Study: possible to predict stock market crashes

August 28, 2009

The most obvious way to predict a stock market crash is to find out when I go all in. But there may be another, says New Scientist:

Now a team of physicists and financiers have bucked the trend by successfully predicting a steep fall in the Shanghai Stock Exchange. …  The idea is that if a plot of the logarithm of the market’s value over time deviates upwards from a straight line, it’s a clear warning that people are investing simply because the market is rising rather than paying heed to the intrinsic worth of companies. By projecting the trend, the team can predict when growth will become unsustainable and the market will crash.

Sornette, Zhou and colleagues applied their model to the Shanghai Composite Index, which tracks the combined worth of all companies listed on the Shanghai Stock Exchange, the world’s second largest. Early this year, the index gained 50 per cent in just four months. In July, the team predicted that the index would start to fall sharply by 10 August. The index duly began to slide on 4 August, falling almost 20 per cent in the subsequent two weeks.

Me: I assume this would also work with individual stocks. Econophysicist Didier Sornette has a paper that puts his approach in a bit more context.

One comment

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Posted by James Pethokoukis » Blog Archive » Study: possible to predict … | kozmom news | Report as abusive

This is a very interesting development! I figured there was a way to predict steep drops based on an accelerating upward trend, kind of like an asymptote. This could prove invaluable in the future.

However, I did not need a logarithm to predict that the Shanghai index would fall. All the news surrounding the Chinese economy points to an inflated stock market based on inflated real estate and excessive risky lending.

Personally, I think the Shanghai index is a lagging indicator, and it will likely fall precipitously sometime this fall/winter. I dont believe that China is immune to the world financial crisis, it just hasnt caught up with the rest of us yet. It will be very interesting to see the consequences of this situation.

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