The 10 stages cycle of a typical stock market crash

Stage One – The Euphoric Build Up

This is the point of maximum financial risk as the market builds towards a peak- where Wealth Managers feel invincible. 1986 and 1987 were banner years for the stock market. These years were an extension of an extremely powerful bull market that had started in the summer of 1982. In 1987 it was five year bull run up while the 2008 crash had earlier seen run up of again just over 5 years ever since the end of the “dot com crash” which started on October 9th 2002. As can be seen below, the bull market can take various numbers of days but most have taken just over 2000 days.

Stage Two – The Final Top

The second stage is a crescendo in the market – this is often the peak before the market crashes and is characterized by complacency and the sentiment of the investor is a general feeling of “I can buy any stock and it will go up”. As you can see from the Chart 6.3: (Oct 2006-September 2007 Dow Jones Industrials) below it can be quite euphoric at or near the final top with a steep rise in Index values.

Summary of Stage 2:

1987 - Dow on 25th August 1987 - Dow was 2722.45, (peak)

2007- Dow on 9th October 2007 - Dow was 14,164

Chart 6.3: Oct 2006- September 2007 Dow Jones Industrials

Stage Three – Testing Support

This third stage is a slight but not a severe drop and can last between 28 and 36 trading days. There can be many re-tests during this period. The drop here can vary but it rarely exceeds 25%. Sentiment of the investor is unsure but still relatively positive – gone is the over- exuberance and present is slightly more insecurity. Clients react to bad news by scrambling to protect their wealth and maximize profits. Bullish investors see the low prices as buying signals while those holding short positions see them as opportunities to take profits.  In 1987 it started to test support on 18th September 1987 whilst in 2008 it had tested support much earlier that year on January 22nd 2008.

Summary of Stage 3:

Test support levels 1987

Dow on Sept 8th 1987– Dow at 2545

Dow on Sept 21th 1987 – Dow at 2499

Dow on 12 Oct 1987 – Dow at 2464

                   

Test support levels 2008,

Dow on Sept 17 2008– Dow at 10616

Dow on Sept 29 2008 – Dow at 10381

Stage Four – Panic Selling

While much is written about this period nevertheless ironically it only lasts a few days – typically 6-9 days but can amount to a drop of up to 40%. In 1987 it dropped 37% in only trading 4 days (between October 13th and October 19th) while in 2008 it dropped 28% in the first 7 trading days. This short period of panic selling, typically accounts for the biggest drop. There is fear and panic amongst clients and Wealth Managers.

Summary of Stage 4:

Panic Selling from

Dow on Oct 13 1987– Dow at 2496

Dow on Oct 19 1987 – Dow at 1735

Dow on Oct 1 2008– Dow at 10838

Dow on Oct 10 2008 – Dow at 8481

Stage Five – The First Bottom:

By now the market has dropped between 21-41% and there is often a general sense of “I can start averaging here” but that is too early! The period lasts 40 to 44 days and in 1987 lasted 40 trading days and the Dow had fallen 41% whilst in 2008 lasted 44 days – by now the Dow had fallen 34%

Summary of Stage 5:

Dow on October 19– Dow at 1735

Dow on Oct 10 2008 – Dow at 8481

Stage Six – Bounce After the First Bottom:

Here there is a feeling of “ït could be over very soon” but it rarely is! As investors see the market rising the pent up feeling of Ï must take advantage of this crash” starts to take hold. In 1987 this bounce could be seen on 21st October 1987 where it rallied 28% while in 2008 this was on October 13th 2008 when the market gained 25%

Summary of Stage 6:

Bounces…

Dow on Oct 21 1987– Dow at 2081

Dow on Oct 13 2008 – Dow at 9794

Stage Seven – The Second Bottom:

Here there is a sense of “here we go again!” as clients rush to exit thinking that they have seen this story before and do not want to hold stock. In 1987 this was reached on October 28th whilst in 2008 it was reached on October 27th.

Summary of Stage 7:

Dow on Oct 26 1987– Dow at 1796

Dow on Oct 27 2008 – Dow at 8161

Stage Eight – Bounce after second bottom:

This bounce is with less conviction than the first bounce but it is a more important bounce as it is nearer to the market recovering. In 1987 it was on October 30th and in 2008 it was on October 28th and 29th. In both it re-gained 16% of its value.

Summary of Stage 8:

Dow on Oct 30 1987– Dow at 2049

Dow on Nov 4 2008 – Dow at 9653

Stage Nine – The Final (Deepest) Bottom:

This is often called the 3rd Wave ( see Ralph Nelson Elliott is the father of the Wave Theory) and in 1987 it was on November 20th whilst in 2008 it was actually the following year – March 9th 2009 – which became famous because the  late, great Mark Haines (a CNBC anchor at the time) stepped "out on a limb" and called the bottom of the market's free fall and became the bottom of the market became known thereafter as “Mark’s Bottom”!

Summary of Stage 9:

Dow on Dec 4 1987– Dow at 1763

Dow on Nov 20 2008 – Dow at 7491

Stage Ten – The Initial Tentative Recovery:

This usually but not always starts off when it is at 67% of the 200-day moving average (see for example the Chart 6.6 below) and was exemplified in the Mark Haines pronouncement of the “market bottom” which came to be known as the “Haines Bottom” when Mark Haines Calls the Stock Market Bottom of a 2 year bear market on March 10, 2009 – the precise day of the bottom. From there on a market will start the inexorable climb back. This stage will morph into a sustained rally but will be gradual rather than euphoric. (Pisani, 2015)