RJ Hamster
Do This Now Before the Inevitable Meltdown
Do This Now Before the Inevitable Meltdown
Note from Senior Editor Michael Salvatore: Today, we’re sharing an invaluable piece from TradeSmith CEO Keith Kaplan on risk management during sudden market shifts.
AI-driven market moves have made this guidance more important than ever.
We can’t say for sure whether the Mega Melt-Up of the last several years is turning into a meltdown. Our indicators are all still in the green, so it’s too early to call.
But we do know that regularly auditing your portfolio, defining your exit strategy, and using TradeSmith’s objective risk tools are key parts of keeping your financial house in order. That’s just as important in good times as in bad. Read on for more from Keith on how to do just that…
BY KEITH KAPLAN
CEO, TRADESMITH
In the summer of 1929, the papers were full of stories celebrating the radio boom and its brightest star, the Radio Corporation of America (RCA). And while this story took place nearly a hundred years ago, it’s hardly unique.
RCA was the company behind the newly launched NBC network.
And its soaring stock price had become shorthand for the new communications technology it dominated: radio.
Americans were buying about 10 million sets a year. And they were tuning into Amos ’n’ Andy, Bing Crosby, and the World Series from their living rooms… often on radio sets RCA manufactured.
RCA’s shares had climbed from about $43 in 1926 to more than $500 by the late summer of 1929 — a 12-fold gain that turned stockholders into millionaires.
To investors, it wasn’t just a company. It was a stock that could change your life.
Eight weeks later, the stock market crashed. And RCA went from $568 to $26 — a 95% plunge that erased nearly every fortune it had minted.
The RCA story repeated in the 1990s when a new communications technology called the internet promised to change everything: work, communication, even money itself.
I was building websites and software in the late 1990s. So I remember it well.
Dot-com firms were losing millions of dollars. But their stocks were skyrocketing. It made no sense. But I had a deep sense of FOMO, nonetheless.
By 1999, the tech-dominated Nasdaq had roughly doubled in 18 months. This kicked off what The Wall Street Journal called a “national day-trading fever.”
In Houston, one of its reporters visited Momentum Securities, where former engineers, teachers, and salespeople had quit their jobs to trade dot-com stocks full-time.
Rows of Dell computer screens glowed across the room. Traders high-fived when stocks surged. Some made more in a week than they’d earned in a year in their former jobs.
When the Nasdaq topped 5,000 in March 2000, it felt as though a new era had begun. A year later, it had plunged by about 60%.
Those makeshift trading rooms emptied out. And the fortunes that had been made in them went up in smoke.
Now, something extraordinary is happening again in tech. Except this time it isn’t a new form of communication — it’s a new form of intelligence.
Since ChatGPT launched in November 2022, artificial intelligence stocks have soared. So have stocks in companies “implementing” AI to drive efficiencies.
Nvidia’s stock price has surged more than 1,100%. And smaller AI-related stocks have risen even higher. Together, they’ve helped the Nasdaq nearly double over the past two years.
And like similar cases in the past, this is at once a massive opportunity and a potential trap.
You see, a breakthrough new technology tied to eye-popping stock market gains isn’t the only thing linking the late 1920s, late 1990s, and mid-2020s. Two other forces run through each of these “Mega Melt-Ups.”
So today, let’s look at what a Mega Melt-Up is and what causes it. Then I’ll show you how you can capture any future upside while protecting yourself from losses in the inevitable meltdown.
If you’ve been watching the markets this week, you’ll know they’ve been shaky. Understanding these dynamics and taking action to protect your downside risk couldn’t be timelier.
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The Three Telltale Signs of a Mega Melt-Up
A melt-up is when markets stop rising rationally and start going vertical. It’s the final sprint before gravity takes over.
A Mega Melt-Up is an unusually powerful version of that dynamic that happens when three life-changing forces collide.
In the 1920s, it wasn’t just excitement over new technologies like radio, electrification, and aviation that sent stocks soaring. It was also the result of the rise in margin loans, which let ordinary people borrow to buy stocks. And there was an explosion of consumer credit that powered the broader economy at the same time.
Something similar unfolded in the 1990s.
First, the growth of the commercial internet. Second, online brokerage accounts made trading instant and cheaper than it had ever been. And third, easy credit and home-equity loans fueled a sense of limitless possibility.
Every Mega Melt-Up is the result of the same three forces: a transformative general-purpose technology, easy market access, and abundant credit. Here’s how those forces are in play today:
- AI is sparking a productivity boom unlike anything we’ve seen.
- Zero-commission trading and fractional shares have opened the door to millions of new investors.
- Consumer credit balances are at record highs, giving the economy both fuel and fragility.
We may still have years left to run. It could just be months. It may be weeks. But history tells us every melt-up ends the same way: with a meltdown.
It could be backlash against AI taking people’s jobs. Credit could tighten suddenly. Or investors could lose confidence in richly valued AI plays. When stocks are priced to perfection, it doesn’t take much to flip the switch from bullish to bearish.
The goal isn’t to panic or hide in cash — it’s to be strategic. You want to capture gains and protect yourself from the inevitable reversal.
Step 1: Review Every Long-Term Investment You Own
If you’re holding anything long term — index funds, dividend stocks, or even crypto — ask yourself: Why am I in this position?
Write it down. What was your original reason for buying? Has that reason changed? Is the company still growing earnings? Or is the story all hype?
Most investors never do this audit. But markets reward clarity and punish complacency. And a melt-up is the time to tighten your thinking.
Step 2: Define Your Exit Before Emotion Takes Over
Every great investor I know defines, in advance, what would make them sell.
It could be a fundamental reason — slowing earnings, rising debt, or a broken growth story. It could be valuation related. Or it could be a decisive drop below a key support level.
Whatever the trigger, you want to decide it before emotion takes over.
Step 3: Protect Yourself with an Exit Strategy
If you’re not sure where to start, here are three proven exit strategies you can use:
- The 25% Rule: Place a trailing stop 25% below your entry price. If the stock falls that much from a peak, sell automatically. It’s a mechanical, emotion-free way to protect your capital.
- The 2x Rule: Once a stock doubles, sell half. That locks in your original capital and lets the rest ride on “house money.”
- The TradeSmith VQ Stop Loss:This one is obviously our favorite. Every stock has a unique “Volatility Quotient,” or VQ — its natural rhythm of movement. Some swing 10% in a week. Others barely move. Our algorithm tracks this pattern and issues a sell signal when a move breaks outside its normal range.
It’s how I got out before the Covid Crash and before the 2022 bear market. It’s also what keeps me confident staying in positions during a melt-up.
Whatever method you use — use something. Define it NOW. Make it a rule that you follow, no matter what. Kill the emotions that drive investments into the ground.
The Bottom Line
Nobody can see exactly when a Mega Melt-Up will end. But when it does, it will happen fast and will shock you with its ferocity.
So don’t just chase the next hot AI stock. Use this time to upgrade your investing process. Audit your holdings. Define your exits. And if you want a data-driven edge, use a strict stop-loss system like TradeSmith’s VQ.
Instead of using the same one-size-fits-all rule, it gives you a personalized stop-loss level for every position in your portfolio. This allows you to stay invested longer in strong-but-volatile stocks and avoid selling too early.
At the very least, add trailing stops to your portfolio. It’s an easy way to avoid the kind of ruinous losses investors suffered when the last two Mega Melt-Ups ended in 1929 and 2000.
By combining conviction with discipline, you can still participate in any remaining upside while making sure you have a plan to get out before the inevitable meltdown.
Sincerely,
Keith Kaplan
CEO, TradeSmith
