How to predict a stock market crash and what you can do about it

In this guide, we look at how to anticipate a market decline and what you can do about it, including the key warning signs of when the market may crash. What barometers to use to spot them, how to position your portfolio for a correction and proactive opportunities around a crash.

We are horns deep into a bull market cycle in US equities, the indices on which have recently reached new all-time highs, many other asset classes like (Bitcoin) have also enjoyed solid gains during 2025. But, a bull market is often likened to a giant party, this party may last for some time. However, markets are cyclical in nature and it’s said that the best time to leave a party is just before the end.

• Related reading: Stock market crash statistics

How Bull Markets End: The Anatomy of a Bull Market Top

Modern financial eras are defined by bull and bear markets. They interchange like day and night. But one is filled with fun and joy; the other, pain and misery. Humans, naturally, prefer the former. Pleasure over pain, always.

Long secular bull markets last for at least a generation. When, if you can remember vaguely, was the last severe bear market in America? 2008-9. That was nearly 17 years ago!

Since then, the US S&P 500 has been advancing steadily and, in recent years, the advancement has angled parabolically. The technology sector (see Nasdaq QQQ below) performed even better. These stock indices kept climbing to new all-time highs, over the wall of economic worries such as tariffs, high interest and growth shocks. What seemed impossible earlier became a stark reality.

Peppering along this secular bull market were cyclical downturns, for example, during Covid and post-Covid boom (2022-3). These downturns lasted just months. Short corrections and long rallies are just the sort of pattern that instil market confidence.

What, you wonder, will end a long bull market? Historically, there are three primary reasons:

1. Over-valuation – that is, investors overpay for future earnings and growth
2. Over-heated economy – which resulted in higher interest rates, which reduces economic growth and corporate profits
3. Over-leveraged bull runs – which resulted in precarious speculative mania

As of October 2025, are we in any of these situations? Let’s take a quick look.

US stock valuation

The most recent Shiller CAPE does reflect a scary figure. The Cyclically Adjust Price-Earning ratio, a widely-used measure of US market valuation, rose to its second highest reading in a century: 39.

The P-E ratio is the multiple of earnings that investors are prepared to pay to own a company. The higher the PE multiple, the more bullish investors are.

The highest level was recorded during the 2000 dot-com bubble (44). And the third highest reading was noted just a couple of years earlier during the post-Covid stock boom (2021; 38).

Is the market overvalued? According to these historical figures, the answer is a definitive ‘yes’! Just looked at the chart below. In 2008, the figure was only 12. Basically, the market is very optimistic. Investors are paying dearly for future corporate growth and to own a stream of (cyclically-high) profits.

If there is anything to learn from this chart, it is this: Subsequent market returns after reaching these CAPE peaks (above 38) are not good. The risk of a market correction rises as valuation climbs.

Source: gurufocus.com (Oct 2025)

Over-leveraged Speculation

The second item that interests us is financial speculation.

A stock boom means one thing for many investors – easy money. Millions and millions in wealth, at least on paper, are created. This resulted in overconfidence and hubris. Assuming that the equity will last forever (the infamous ‘This Time Is Different’), they borrow and leverage to the hilt to maximise wealth gain.

How is the margin debt looking in the US now? Very high.

According to the latest figures from FINRA, a self-regulatory association, US margin debt is at its highest level ever (September figures, not shown on chart). Traders and investors are relying increasingly on margin debt to boost their returns.

Remember, these figures don’t include the margin trading over at the cryto sector. Any downturn in market prices will result in margin calls and forced selling.

Source: advisorperspectives.com (Sep 2025)

What is New This Time? An AI Bubble?

Every bull market starts at a depressed level and ends on a fantastic valuation. We are fast approaching this ‘fantasy’ valuation (see above).

In addition, most bull markets were injected with a novel technology. Remember, railroad was once a new “tech”. In 2000, it was the dot-com. So what is the new thing now? Artificial Intelligence.

In the past year, investors (large and small) chased the hottest AI stock. Look at the surge in valuation below. The Top 10 (unlisted) AI companies gained $1 trillion in value in just 12 months. OpenAI, owner of ChatGPT, spearheaded this ballooning valuation. It now sports a $500 billion capitalisation.

The remarkable thing is, all 10 – yes all of them – don’t make a cent of profit, yet.

Source: Financial Times (16 Oct 2025), paywall

How to tell (roughly) when a long bull market is running out of steam

We all know that the US equity market (as of 4Q 2025) is amidst an extraordinary bull run. Speculative activities are rampant, stock valuation are at historic highs and investors are never more optimistic.

But these charts and figures will not tell investors the most crucial date they desire to know – the day when the bull market ends. Unfortunately, no indicator, chart or economic trend will tell you this.

Therefore, every great investor, past and present, cautioned against trying to pick market tops and bottoms. “Forecasts,” observed late Peter Bernstein, “create the mirage that the future is knowable.”

What we can do, however, is to assess probabilities – and use our common sense. Detach yourself from the market (or the crowd) and focus on the big picture. Until you do this, you’re likely to be impacted by the unending bullish chatter in the echo chamber.

For example, if a sector became red-hot and prices suddenly went ballistic, perhaps it is time to step back and ask: Is it worth staying? What are the chances of a correction? Are investors pricing in an overly-optimistic scenario?

Trees, as they all say, don’t grow to the sky. In market parlance, this means stock prices tend to ‘mean revert’ to their long-term trend. So rather than looking for specific levels to trade against we should look for signs and signals that the market is turning.

What sort of market signs should we pay attention to ? Here are my top 10 favourite factors, which range from valuation to psychology:

1. Extreme price rallies – meaning most future positive events are priced in
2. Historic high valuation – whether it is price-earnings or price-to-book ratio, see eg CAPE above
3. Rising interest rates – which often result in tighter credit and more expensive borrowings
4. Sudden earnings miss – which result in sharp share price declines; lofty expectations meet reality
5. Slowing price momentum – indicating stock supply is coming into balance against demand, eg prices slump below 150-day moving average
6. Diverging technical indicators – especially against bullish price trends
7. Narrowing leadership – meaning a smaller and smaller number of stocks are carrying the bull market higher
8. Falling breadth numbers – suggesting more and more stocks have stopped rallying; a strong bull market means most stocks should go up (see below)
9. Sky-high leverage – as traders load up on stock debt, any drop will lead to margin calls and forced selling
10. Unbounded optimism – ‘to the moon’ and inexperience Main Street FOMO in

During a long bull market (or a bubble), the crowd adopts tunnel vision and never even sees the warning signs that signal the cliff edge ahead.

You should try not to make the same mistake. Use common sense and practice some basic risk management rules would do a lot of good for your investment portfolio!

Source: yardeni.com

How to protect your portfolio from a stock market crash

Investment is all about calculating probabilities, or the odds of winning, over the long run.

When investing, the first cardinal rule that everyone must remember is this: Do not lose your entire stake. No money means no investment. No investment, no returns. Simple as that.

Once you start thinking along this line, you will quickly recognise that, to enhance long-term returns, you will need some: a) “margin of safety” and b) diversification. Both are crucial to ensure you stay in the game as long as possible to reap the benefits of an upswing

Generally your investment portfolio should entail three asset classes:

• Risky assets – stocks, equity funds, crypto
• Not-so-risky assets – bonds, gold
• Cash

To protect your portfolio during a downturn, you vary the allocation to each category dynamically.

For example, during a bull market, equity prices rise strongly. After a while (a time frame measured in years), you start to reduce equity allocation by selling down some stakes and increase your cash portion.

As of October 2025, who is doing this right now? The legendary Warren Buffett. Through his holding company, Berkshire Hathaway (BRK.A), the veteran investor is scaling back equity investments in Apple (AAPL) and others. His cash and short-term Treasuries has swelled to a total of $340 billion, slightly more than his equity holdings.

So what strategies should you do to protect your portfolio from a sudden market downturn? Three broad tactics (specifics will vary according to different accounts) that you look for:

1. Increase cash holdings – by selling some equity stakes to prepare for a potential market correction. You may exercise this strategy periodically, eg monthly, instead of trying to ‘time the exit’ to perfection. Or you can use technicals, ie, sell some when prices drop below 200-day moving average. Going full cash would be an extreme example.
2. Increase holdings of undervalued/fairly valued markets – US stocks are expensive while Rest-Of-World markets are cheaper. Switch some US stocks into these inexpensive stocks. This is relative rotation. One example is the $250 billion Vanguard ex-US Developed Market ETF (ticker:VEA, factsheet, see below).
3. Increase defensive holdings – such as short-term US Treasuries or defensive sectors (eg consumer staples)

Remember, as a long-term investor we are not trying to pick the exact top. That’s near impossible. Rather, we may want to reduce some equity stakes during a strong rally to prepare for a potential decline as to maximise returns by buying back in a cheaper prices.

Proactive and more aggressive measures to profit from the downside

For more astute investors, some further aggressive tactics can be used to profit from strong downside moves.

For this, I assume that these readers are a) experienced enough to gauge prices and technicals and, b) holding sufficient capital buffer to trade.

There are a few ways to trade the short side of the market. Many of them utilise financial derivatives to gain from the price difference.

Instruments available to long-short trades include:

• Financial futures – such as S&P Mini, Dow, and Nasdaq Mini
• Options – on major indices
• Inverse equity ETFs – which appreciate when indices decline
• CFDs – spread betting on the direction of major indices

We take a quick look at each of them below.

Financial Futures

Futures allow investors bet on either direction of the underlying index.

For example, here is a chart of the S&P 500 Mini Future (Dec contract, ticker: ES). The contract size is $50 times the index level (currently at 6,670). In a way, this embedded leverage allows traders to profit significantly from any downside move. See full contract specification here.

The problem, however, is the potential for sellers to suffer large losses on the upside. Holding a short position will require a huge dose of margin credit if the underlying index rally further. You will need to rollover the position every quarter.

Source: Barchart.com

Options hedging

Options provide option buyers with the right but not the obligation to buy or sell a given amount of an instrument at a fixed price (the strike price) over a given period.

Options on indices are typically cash-settled and options trades on any instrument effected as CFDs or spread bets will by nature be cash-settled. The right to buy known as the “call option” and the right to sell known as the “put option”.

To protect ourselves on the downside, or to potentially profit from downside moves, we look to buy put options. An options’ value is largely determined by two factors:

• Time value – the duration or lifetime of an option before it expires. An option with three months to expiry will be worth more than the equivalent option with only a month to expiry
• Intrinsic value – determined by its position relative to the price of the underlying instrument

If, for example, a put option allows you to sell an instrument at £1.10 when the underlying price is £1.00 that option has 10p of intrinsic value and it is said to be 10p “in the money”.

The benefit of hedging through buying put options is that we pay a known and fixed amount (the option premium) at the outset of the trade. That is our total outlay.

If the put option comes into or moves deeper into the money (ie, underlying instrument drops below the option strike price), then our option will rise in value and you can sell for profit. But most options expire worthless (no time nor intrinsic value). In that case, we will have “wasted” our premium.

The way to think about options in this situation, however, may be to consider them as an insurance policy that is you pay the premium hoping you will never need to claim but are happy to do so because you are protecting yourself from worst-case scenarios.

Inverse ETFs

Inverse ETFs are created so the buyers of these ETFs will profit from significant downside moves (of the index that it tracks).

One of the largest inverse ETFs is the ProShares Ultra Short QQQ (Ticker: SQQQ, factsheet). Not only does the ETF move inversely to the Nasdaq 100 Index, it moves 3x the daily performance of the equity index. In other words, this is a highly leverage ETF.

On paper, this sounds great for equity investors looking to hedge their tech stocks. But is it suitable for investors to keep holding it over a long period? Not exactly.

Look at SQQQ’s performance throughout the long bull market. Prices kept falling due to the ETF’s re-balancing effect. So if you want to use inverse ETFs to hedge your underlying portfolio, make sure you use it for a limited time only.

CFDs/Spreadbetting

CFD is a method of creating financial exposure to a particular instrument synthetically (ie without owning the actual instruments).

But you will still gain (or loss) capital on any price moves, which allow investors to hedge their downside exposure.

See GMG CFD Guide here.

If we have a portfolio of leading UK stocks worth say £100,000, we can protect ourselves by selling a similar-sized position in FTSE 100 CFDs or spread bets.

If the market does crash, then the short CFD or spread bet position will become profitable and help to offset any losses incurred in our equity portfolio. The goal here is not so much to make money but rather to minimise our losses.

Of course, by going short of the index through a CFD or spread bet we open ourselves up to risk on the upside as well, and if the market moves against we will need to have sufficient free margin to maintain that position, for as long as want it to be in place.

Final Remarks

At the end of the day, no hedging is perfect. What to hedge, using which instruments to hedge, the capital outlay and market volatility all play a big part in the design of these programs.