I’m going to pander to the bulls for a moment.

This short article warns about taking all of the crash predictions as a contrarian indicator. But is a crash something a huge percentage of people can predict? Is it possible for a crash to be a self-fulfilling prophesy when advance notice is given by so many? Obviously the crash itself requires a huge chunk of people to give up at once. Everyone stampedes towards the exits. It is perhaps the definition of herd mentality. That’s during the crash, not before. If the crash were predicted in advance by so many, enough hedges should be in place that the group doesn’t have to rush for the exits. So how do we get from everyone predicting a crash to everyone panicking during a crash?

If you are bullish, you frequently look for a wall of worry to be climbed. Typically that wall of worry is from people who already sold, expecting more downside. Despite the huge run in the stock market over the last year, this still largely applies. You expect gains as people who already sold get back in the market. Unfortunately, that doesn’t appear to be happening (people appear to be heading towards the exits right now, just in a somewhat orderly fashion).

This isn’t the strongest argument, and a lot of pretty smart people are calling for a crash, so let’s also look at some of the bearish issues for the dynamics (for the fundamentals or technical issues, I assume you can read any of the other crash predictions).

If you are bearish to the point of looking for the crash, you need to find the transition mechanism. How can people go from expecting and preparing for the worst to being caught off guard and panicking? Does it require an outside trigger? Is it just a matter of people being fully hedged waiting to pounce on the downside? If that’s the case, there are plenty of triggers to choose from.

All a crash really requires is an absence of buyers. If enough sell orders are in the pipe and nobody is around to make a bid, the market gaps lower to a point where someone is willing to step in and buy. The gap down can trigger stop orders, exacerbating the move downward, causing bargain hunters to shift their bids even lower. I’m inclined to believe that the “flash crash” cleared out enough stop orders and spooked enough people that most are now relying on stop limit orders with their brokers. That would upset the crash dynamic a bit. The market makers and specialists can fulfill the role of bargain hunters, but expect large gaps down if this is the case. I throw this otherwise useless tidbit out to explain the resolution of an interesting imbalance: for the transactions to occur, there must be a buyer for every seller, but the dynamics don’t require that they all issue their orders at the same time. The expectation that orders are somehow fulfilled instantly is the problem, not the view that there can be more sellers than buyers at a given moment.

A technical issue to consider—and this has little to do with dynamics and everything to do with how to interpret the article’s thesis—is that crashes tend to occur from oversold positions. Clearly the pessimism exists leading up to the crash at some level. It’s a bit like 9 times out of 10 (even more lopsided) oversold indicators predict a reversal. It’s that leftover bit that can wipe someone out. While the odds might favor the contrarian bull, the expected value might not.

I’m obviously in the “this won’t end well, but I’m unwilling/unable to predict when” category. Personally, I reacted to this article with relative relief. I’m still quite bearish, but less worried of an immediate crash than before (again, that worry is relative). But please, read the crash calls yourself and determine which camp you are in.