Discovering Why Stock Markets Crash
Who doesn’t love a good stock market crash? Outside of short term traders, it’s an opportunity to reload your portfolio if you’re a long term investor and a chance to dip your toes into the world of Wall Street in if your a newbie. The lore associated with stock market crashes fascinate nearly all involved in the game of investing, just is the case that the fear of a crash.
While it’s easy to get caught up in the drama surrounding a crashing market, this book attempts to pinpoint the reasons that actually cause the markets to fall through analysis of previous crashes, simulated models, and high tech math equations. While it’s easy to fault the book for being too technical, I feel that the author does a great job at explaining the science behind that math and offers solid insights that any trader will appreciate.
Didier Sornette starts the book where you would expect any study of stock market crashes to start, with many of the most famous stock market crashes history. I found this interesting as there is always some nugget of information that one did not know previously when studying history such as how the South Sea Bubble was very much like the ponzi schemes of late . Given that the book was published in 2003, it’s a shame that it wasn’t published recently, as it would have been interesting to see the author’s take on the economic collapse of ’08 and the subsequent Flash Crash that occurred on May 6hth, 2010. Although when you look back at a daily chart of the Dow Jones, the Flash Crash barely registers a blip on the recent economic recovery. If there’s one thing that all crashes have in common, it’s that they “are caused by the slow build-up of long-range correlations leading to a global cooperative behavior of the market”.
The author pits the random walk theory verses the efficient market theory and I couldn’t discern a clear winner as I made my way through the many charts and complicated formulas that only a geophysicist such as Sornette would truly understand and appreciate. I feel you should replace the word random with irrational, as “that rationality tends to be hampered by cognitive biases, emotional quirks, and social influences.” Your social network that you discuss the markets with, be it your friends, family, or fellow Twitterers, become your tribe and have a large influence over your trading and investment decisions.