Q. Do you expect a crash?
Sykes: I would say there are better odds of a crash than a big spike. I am a short seller. I have a short bias. With our debt and government interventions, eventually something could happen, even if it won’t last. People get freaked out pretty fast.
I don’t know if there will be a crash. The debt and dollar would make the most sense. If we get downgraded, that could cause a crash. There’s a lot of danger on the horizon. One thing I do know: shorting is difficult. You cannot stay short or you will be crushed. It reminds me of the guy who predicted the end of the world several times. It’s no different than people who predict Dow 40,000. They are looking for attention.
Q. What are some clues that precede a crash?
Sykes: Seasonality is a big part of it. Another big clue is when you have a lot of speculative things flying. That is usually the end of a bull market. You can make the case about the Twitter, Facebook, Linked In, and Pandora valuations. It’s possibly a bubble. It sounds amazing; all these companies and their amazing business models. People think these businesses will never stop growing, but that is just bull. With all this stuff flying, it could well signal the end. A lot of IPOs are coming out and raising cash so we’ll have to see.
Q. When do crashes occur?
Sykes: First of all, historically crashes have occurred the most often in September and October, so you need to be extra aware during these two months. Crashes usually don’t happen out of the blue, although sometimes they do. Usually, a market will be downtrending, and people are selling, and then they’ll puke it up in one day. This is momentum that is usually built up over days and weeks. Always be aware of gradual downtrends where there are no bounces. This can lead to a blowoff.
Q. Are there other clues the market might crash?
Sykes: I look to see if the media says we’ve been down 10 or 12 days in a row, and that it’s a record. Even though it’s meaningless, it influences people. It causes people to want to exit in mass. It’s like a run on the bank, and people are influenced by fear. I follow the downtrend or very influential news. It’s no different than buying, that is, when you are looking for positive news.
Q. Can people call the top of the market?
Sykes: People love to call the top because they think there will be a crash from the top. Rarely do you find a specific crash at the top. You might find it failing to break out to new highs. Crashes don’t usually happen at the top, they usually happen after several days or hours of fading. Because people have their stops at the previous high, it can also create a massive short squeeze. That’s why I don’t try to pick tops.
Q. How would you trade a potential crash?
Sykes: I wait for a bounce. I don’t like shorting after a giant drop. I like shorting after a bounce or a failed bounce. If you short into a free-falling market, although you can make quick profits right away, you can also get a violent snap-back rally. That is difficult to protect yourself. But in every single crash throughout history, there has been a bounce, no matter how fleeting. It might not be huge or long, but if you can sit in cash during the crash, you have an opportunity. The best opportunities are during flash crashes.
Note: Part II of my interview with Timothy Sykes will be posted on this Web site in approximately two weeks.