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Posted on 13 July 2011 | 5,150 views

Timing Stock Market Crashes

Spotting a major turn in the stock market and avoiding a stock market crash could be the difference between retiring in style or not retiring at all.

Trying to accurately predict the unpredictable, such as the May 2010 “Flash Crash” — when the Dow Jones Industrials fell almost 1,000 points in minutes before recovering or the one-day disaster such as the Oct. 19, 1987 stock market crash which wiped out nearly 23% of the Dow’s value is not what we’re talking about.

Trying to avoid the bulk of the financial pain caused by slower-moving stock market crashes, such as the 57% drop in the 2007-2009 “Bear Market” is.

Here’s what the Wall Street pros are watching right now to help them determine if the current 27-month bull market is nearing an end and how investors can avoid falling over the proverbial stock market cliff.

1. Economic Relapse — If the economy, which has been in growth mode since the end of the recession in June 2009, shows signs of lapsing into another recession, it’s likely the stock market will suffer a reversal and turn sharply lower, says James Paulsen, chief investment strategist at Wells Capital Management.

2. Lower Lows — If major stock indexes such as the Standard & Poor’s 500 and Dow start carving out a pattern of lower lows and lower highs, it could suggest market momentum has been lost. If the market falls below previous key lows, such as the S&P 500’s intraday low of about 1250 in March 2011, when selling intensified due to Japan’s nuclear accident, it could presage steeper losses to come, says Bruce Bittles, investment strategist at Baird. “If selling took out 1250 on the S&P 500, it would suggest a change in character for the market,” says Bittles.

3. Risk-Off Trade — Sure, earnings drive the market, but the market is really driven by risk taking, says Chris Johnson, CEO and chief investment strategist at Johnson Research Group. If investors go from a risk-on to a risk-off mentality, be wary, he says.

4. Trend Change — If a broad index of stocks, such as the S&P 500, falls below its average price established over a long period, it’s a sign the up trend has been broken and a new down trend established, says Todd Salamone, senior vice president of research at Schaeffer’s Investment Research. He likes to use a 20-month moving average for the S&P 500, which is roughly 1186 points now. If the index falls below its long-term trend line, that’s a potential sign of a major turn for the market. “The 20-month average price has been a decent roadmap,” says Salamone.

Currently, the stock market is selling at roughly 13 times 2011 profit estimates, below the average P-E of 15, and isn’t flashing a warning. Investor euphoria, which often appears at market tops, is also missing. Other bull market killers, such as a sharp rise in interest rates or a rapid jump in inflation are also absent, at least for now.

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