When The Big Short premiered in 2015, made millions at the box office, and scooped up several Academy Award nominations, I was a 17-year-old kid who didn’t understand finances much. If my experience watching the film as a financially illiterate American citizen was like everyone else's, many viewers probably walked out of that theater with renewed faith in their grasp of the economy.

Suddenly, I could understand financial jargon like subprime mortgages and CDOs (collateralized debt obligation) when explained in layman's terms by celebrities like Margot Robbie and Anthony Bourdain. I figured I would be the next Michael Burry (Christian Bale), who made millions by predicting the housing crash before the 2008 recession. All these years, I’ve been waiting for the word recession to start floating around. Now that 2023 has brought this term back into public discourse, some of us The Big Short fans may be thinking, “This is it. It’s our time to shine and become the next millionaire for Christian Bale or Ryan Gosling to portray in a movie.”

Of course, predicting crashes and bearing an uncanny knack for seeing “bubbles” that aren’t meant to be seen looks a lot easier when we’re watching Steve Carrell, Bale, and Gosling do it. In real life, a recession looks a lot scarier when we realize we’ll likely be outside of that small realm of investors who went against groupthink and made millions. We may instead fall into that dreaded category of the general public who find themselves badly impacted by a flawed system.

However, even if watching The Big Short doesn’t mean that becoming a millionaire in a financial crisis is plausible for everyone, it does come with many valuable lessons. It tackles a period in America’s financial history that is eerily starting to parallel today’s financial climate. It also provides valuable advice and guidance for regular citizens about what to look for, how to question overly optimistic economic forecasts, and how to invest their money smartly in the face of a potential recession.

How To See the Signs of a Recession and Find the Next “Big Short”

The premise of The Big Short is that a few outsiders could foresee a disastrous economic event that spurned a recession — in this case, it was the housing market crash of 2008. This doesn’t mean that every recession will be fostered by the same event or that each will be predictable. We can already see differences between 2008 and 2023 in that in 2008, very few individuals foresaw the 2008 recession, whereas we have already received warnings of a recession going into 2023.

Trying to determine when or if there will be a recession can be exhausting. However, the best tip that The Big Short gives is to look and to question. The film opens with the Mark Twain quote, "It ain't what you don't know that gets you into trouble. It's what you know for sure that just ain't so." In the recession of 2008, it wasn't a lack of financial or economic understanding that led to the housing market collapse. It was that people misplaced their belief in the housing market. They thought it was rock solid and chose to ignore the warning signs that an excess of risky loans and private mortgage lending greed posed. It was only those who decided to look for themselves into the housing market, rather than accepting what society claimed, that found the problem.

Burry took this idea of looking and questioning to the next level by sitting and scrolling through thousands upon thousands of lines of fine print from mortgages within mortgage-backed securities. What he found was that banks were profiting off of mortgage bonds that were filled with extremely risky mortgages.

As for why no one else found this was that they didn’t look, and they relied too heavily on formulas. Over and over again, viewers hear the words that the housing market will never crash and house prices never go down. People relied on formulas and assumptions that worked before and believed that correlations that existed then would exist forever. Hence, a major way to predict and prepare for a recession is to expect the unexpected and acknowledge that change can always happen at any time.

Granted, “expect the unexpected” sounds pretty cliche. However, the idea is that economics isn’t as hard as those on Wall Street would like you to think. As Jared Vennett (Gosling) says in the film, “Wall Street loves to use confusing terms to make you think only they can do what they do. Or even better, for you to leave them the f**k alone.” Forbes contributor Michael Molnar backs up this statement by suggesting the key to predicting the next recession is "focusing on the problems with the formulas currently driving much of Wall Street capital flows. It is likely a simple assumption that is fatally flawed yet not so easy to spot under the veneer of Greek mathematical symbols.” 

Some of these tips might also help you see potential shorting opportunities. When someone shorts a stock, it means that they’re betting on the value of a stock going down. As seen in The Big Short, finding a bubble that is about to pop is usually the key to making big profits in shorting. When you find a bubble, you realize that the price of an asset, like a stock, is surging beyond its actual value due to high demand fostered by speculation. Eventually, there comes a point when the asset can’t sustain the inflated price and it crashes, causing a rapid and dramatic plummet in value.

However, bubbles are extremely hard to detect, and there’s no fixed set of rules to determine the underlying value of most assets. Plus, you can’t cap your losses when shorting a stock. When investing in a stock the traditional way, the most you can lose is all of your investment or 100%. If you’re betting against a stock and the stock doubles or triples in value instead of reaching zero, you can be looking at losses of 200% or even 300%. Hence, shorting is something that should be left to those who know how to do it because the risk is just too big. Being on the lookout for signs of a bubble can still be beneficial in helping you prepare for its economic toll, even if you likely won’t try to short it, though.

What Warning Signs of a Recession Should You Look Out For?

There are typical signs of a recession that economists and financial experts warn you to look out for. This includes things like a rise in unemployment, inflation, interest rates, and a decrease in consumer spending, manufacturing, and personal income. However, remember that in 2001 and 2008 very few people foresaw the recession. Both were caused by bubbles — the dot-com bubble in 2001 and the housing bubble in 2008. Hence, you should absolutely keep an eye on inflation and consumer spending, but you should also think of looking where people aren’t looking or where they may not want you to look.

One of the most glorious things about The Big Short is that many of the people who inspired the film are still alive today and are giving some direction on where we should be looking in 2023. For example, Dave Burt, who helped several of The Big Short protagonists bet against the housing market, has warned about a potential second housing market bubble. He thinks a crash could occur due to the issue of the housing market being overvalued by house owners and sellers not accounting for flood risks.

Many states don’t require real estate agents to disclose flood risks to clients, and many choose not to because it does lower the value of a home. He cited a study from Nature Climate Change that estimated the housing market could be overvalued by around $200 billion. The reason this is especially risky is that the housing market isn’t accounting for climate change and what kind of costs it may present in the future. A natural disaster could result in countless individuals losing vast portions of their property values overnight. Failure to prepare for this could spurn another major crash.

It remains to be seen if Burt’s fears are correct. However, it’s just one of many examples of how preparing for a recession isn’t just about tracking numbers and inflation, it’s about being aware in every area and catching potential red flags before it's too late. It’s asking yourself, do you understand the terms of your mortgage? Do you know the value of your property? Are you prepared for unforeseeable circumstances like climate change and natural disasters? Do you know how to mitigate flood risks? Is your home insured? Do you have emergency savings?

When it comes to your money, loans, debts, property, assets, and security, always make sure to question everything and assume nothing. If you feel an inkling that something might change or be brewing, don’t hesitate to use it as an opportunity to prepare.

What The Big Short Says About Investing During a Recession

Another thing that The Big Short shows is that investing one’s money can be profitable even in the face of a recession. However, even big shots like Burry and Mark Baum (Steve Carrell) weren’t immune to risks when investing their money. The number one thing Burry’s bosses and colleagues asked him was, “Are you out of your mind?” No one could see that the housing market was about to crash, so when he bet against it using credit swap defaults, everyone thought he was crazy. Meanwhile, since the collapse didn’t happen right away, he ended up paying millions in premiums. However, he ended up with a profit of $100 million and his investors with a combined $700 million. Even the more amateur investors Jamie (Finn Wittrock) and Charlie (John Magaro) made an $80 million profit off $30 million in investments in insurance premiums.

“Movies like this are amazing because they highlight just how much money someone who understands economics and the stock market at a national to global scale could potentially reap huge rewards,” says Leonard Kim of AdvisorCheck. “However, the downside is that a lot of people get inspired to go and make uneducated positions in the stock market and lose all of their money, because they don’t take the time to spend years understanding the complexity of how the stock market works,” Leonard continued. 

Now, two things made these individuals’ investments successful: 1). They invested in the right thing, and 2). They knew when to sell. Now, investing tens and millions in insurance premiums may not be your most plausible option. Even if you use the tips above to start looking for signs of a bubble, shorting isn’t encouraged for the majority of investors because of its risks. Fortunately, there are safer options to fall back on if you’re new to investing and concerned about delving into it amid fears of a recession.

Even if you don’t make staggering profits like those seen in The Big Short, a recession may actually be a good time to invest in stocks. It’s simple — a recession means that the economy is experiencing a downturn. However, this also naturally means that there will be an upswing on the horizon because recessions are always temporary. Hence, even you can borrow a page from Burry’s book and use signs of a recession as a time to make profits. During a recession, the prices of stocks typically decrease, allowing you to buy low and sell high once the economy improves.

If you are newer to investing, a safe option is to stick with consumer staples and healthcare stocks. Consumer staples and healthcare are two of the 11 stock market sectors and provide services and goods that are the most essential and tend to hold up even in the face of recession. While many consumers can live more frugally and go without certain luxuries and wants in a recession, people still have to eat. They have to drink and buy toilet paper and hygienic products. Coincidentally, when the economy is not as great as it could be, a lot of people turn to drinking alcoholic beverages as well (which have also seen price hikes across the United States, especially in New York and Los Angeles). Similarly, people will get sick or give birth to a newborn or need a check-up. As a result, healthcare and consumer staples companies often show the most resilience in the face of a recession.

Large-cap companies also offer less risky stocks during a recession. Large-cap companies are usually valued at $10 billion and are such big players that they’re expected to weather a recession well. Some companies even intersect in being both consumer staples and large-caps, such as Wal-Mart, Procter & Gamble, and Coca-Cola.

However, there are more ways to invest your money than just stocks. For example, investing in certificates of deposit (CDs) is another option that is looking more appealing lately. This is because, to try to offset inflation, the Federal Reserve has been hiking up interest rates. As a result, CD rates have risen substantially. The thing about CDs and fixed-rate bonds is that they have set rates of interest for the length of their term that don’t change even in the face of a recession. Hence, if your CDs or bonds are insured, it’s very difficult to lose money on this investment. You can also pool your money with professional investors in a mutual fund or invest in many shares in many companies at once by investing in an index fund. Understanding risks, making sure you don’t put all your eggs in one basket and instead diversify your investments, and knowing how much money you could do without for some time are all important when deciding to invest during a recession.

Fortunately, you might not have to decide what stocks to choose on your own, as utilizing the help of a financial advisor is encouraged. Financial advisors offer guidance and advice on investing that is in your best interests. They’ll let you know if you should invest in stocks to begin with, which ones are right for you, how much to invest, and how to diversify your portfolio. This is especially important for those who either do understand the anxiety and stress that comes along with managing a portfolio on your own, or those who just dread or don’t understand how the stock market works at all. Finding a financial advisor is simple using our search tool.

The Big Short Analogies Can Help You Know When To Sell Your Stocks

Identifying an incredible opportunity was just part of how Burry, Baum, Jamie, and Charlie made bank. Once they invested their money, they also had to make sure they got it back. They made a bet with the big banks in which they would pay yearly insurance premiums until the housing market crashed. Then, if the housing market did crash, the big banks would pay them back several times more than their premiums. Banks agreed to this because they didn’t think the housing market could crash. However, the tide turned and many individuals realized the housing market was crashing.

As the crash became imminent, Jamie’s and Charlie’s initial $30 million investment in insurance premiums reached a value of $200 million. The pair could’ve waited for the housing market to crash and collected their $200 million from the banks. Instead, when signs of the crash arose, they sent their friend Ben (Brad Pitt), who was on vacation in England, to a musty pub to sell them ASAP. He ultimately succeeded in nabbing Jamie and Charle $80 million. These two guys must not be that great of investors if they only got $80 million from securities worth $200 million, right?

Not quite. The problem was that Jamie and Charlie didn’t have much faith that the banks would actually follow through on their payouts. These were major banks against very small players. Plus, with banks like Bear Stearns failing, Jamie and Charlie realized they wanted to get rid of their swaps before everything collapsed and left them with potentially no avenue to get the payment they were owed. When the housing market started showing signs of failure, banks and investors took an interest in these lucrative swaps, so people like Jamie and Charlie could sell them.

While they likely made the right choice given their standing as amateur investors who limited the risks they wanted to take, others chose differently. In a taut moment, Baum nearly made a waitress cry while arguing with his team about his refusal to sell his swaps, largely because he didn’t want to help the corrupt big banks. He and his team were one of the absolute last to sell their swaps, and they made a whopping $1 billion.

Burry, Baum, Vennett, Jamie, and Carlie — all found the same investment opportunities, but each took different approaches to how much they wanted to risk on these opportunities, and none of them were wrong.

When you invest in stocks, especially during fears of recession, knowing when to sell a stock is crucial. Unfortunately, there’s no magic formula for knowing the right time. This is because part of the equation is what you specifically want out of a stock. Sometimes, the value goes up a bit, and this is enough for you. Sometimes, you realize you made a mistake, and you want this lousy investment off your plate. Some people are like Baum and will continue gambling to get the maximum profits, while others, like Charlie and Jamie, will take their moderate profit and leave satisfied without taking major risks. For the people who are like Baum, who enter into a gambling mentality, the probability of going down the wrong path and losing your entire life savings could become a stark reality. It happens all too often in the stock market with people who bite off more than they could chew and start making trades to try to get rich quick, but lack the years of education it takes to fully grasp how the stock market maneuvers, both from an analytical standpoint through the graphs and charts, along with a psychological standpoint with how traders make decisions on when to enter into and exit their stock positions. 

During a recession, though, making the call becomes a lot harder. Going into stocks with a long-term outlook will be especially important. You’ll need to refrain from panicking when values drop as expected. However, you’ll also need to be aware that a stock could plunge and not make its way back up.

Examples include Tesla, whose stock value saw a 14,600% increase over its IPO in its first 10 years. Those who invested $1,000 in 2010 would’ve turned that amount into around $147,000 by 2021. There are countless investors who probably invested early, doubled their investments, and decided to tap out, only to leave tens of thousands on the table. However, the dot-com bubble of 2001 shows how speculative investing in dot-com company stocks proved disastrous when their values plummeted and cost investors $5 trillion. So it makes you wonder, did they really leave tens of thousands on the table, or did they make the smart decision to get out when they hit a comfortable profit margin?

A stop-loss order can also help you decide when to sell a stock. These are instructions you set to sell or buy a stock when it reaches a certain value. You might decide that you can’t afford to lose more than 10% of your initial investment in a stock. So, you would incorporate a stop-loss order that your stock be sold at the best price if the stock's value decreases by 10%. If the value decreases by less than 10%, stays the same, or increases, the stop-loss order won’t impact anything. A broker will simply keep an eye on the prices and sell for you if the stock reaches the stop-loss order amount, ensuring that if things go south, your investment isn’t just sitting there losing value until it's all gone.

Many amateurs who get into the stock market don’t study through all the material of what it takes to be a successful investor, and many of them have no idea that stop-loss orders exist and they often see themselves losing more money than they could have ever imagined. That’s why one of the best things you could do if you plan to start investing is to work with a financial advisor, because they are trained fully on how to maintain and grow your investments. Not to mention, they are regulated by governing bodies like FINRA and the SEC. That means if they mess up, they could be on the hook for potential losses, as opposed to taking the losses on yourself with no one else to blame but yourself. If you feel you may need a financial advisor in your life, you can find one using our search tool. 

Ultimately, one of the best things you can do when investing in stocks is to decide beforehand what you want out of it. Are you hoping to make some extra cash ASAP as soon as the value rises, or can you live without the money for a while and let it sit until it yields a satisfactory profit? Would losing that money be devastating, or do you have a little leeway to take some risks and potentially earn a better profit? Selling a stock because the sale works for what you want and how much risk or loss you can take is a better reason to sell than to do so merely because a stock went up or down. A financial advisor can also greatly reduce the stress and the amount of time you spend going back and forth about whether you should sell or not, and they could even completely handle all aspects of your financial porfolios, if that’s the level of service that you’re looking for. They can help you determine what you want out of this investment and ensure that you’re investing in moderation and not taking unnecessary risks.

Have Faith in Your Instincts and Knowledge

Back when I first watched The Big Short, I thought the movie made me too confident in my understanding of economics. However, I realize now that this was the film’s purpose. It was to renew audiences’ confidence in themselves because a lot of us have been through difficult financial situations that made us lose faith in bigger institutions. It emphasizes the necessity to sometimes take matters into our own hands in always questioning and preparing regardless of any promises and assumptions being thrown about. It advocates trusting your instincts and doing what works for you when it comes to your finances. Whether that means grasping an opportunity only you can see, questioning your landlord or your lenders, calling out corruption when you see it, or tentatively making your stand in the stock market — your knowledge, education, and awareness will be one of the most important things to fall back on during uncertain times. This doesn’t mean taking unnecessary risks, but it does mean that sometimes you might understand more than you think you do about economics and money, and there’s really no limit to what you can do with that knowledge.

If you’re feeling renewed confidence in your grasp on finances and are considering entering the world of investing, don’t forget to make a free AdvisorCheck membership to get easy access to our money tips and financial advisors network. As said above, knowledge is a key asset in uncertain economic times, and AdvisorCheck is here to help you expand that knowledge.

Written by Rachel Ulatowski

Fact checked by Billy Quirk

Reviewed by KJ Kim

Disclosure

The information provided in this article was written by the research and analysis team at AdvisorCheck.com to help all consumers in their financial journeys, by providing the resources and the insights to help improve one’s financial health, make it through recessionary and inflationary periods of time, and save their earnings to use them towards building a secure financial future. 

Unauthorized reproduction or use of this material is strictly prohibited without prior approval. Any parties interested in content syndication, references, interviews, or PR, please contact our marketing team at marketing@aimranalytics.com

AdvisorCheck.com is an independent data and analytics company founded on the principles of helping to provide transparency, simplicity, and conflict-free information to all consumers. As an independent company providing conflict-free information, Advisorcheck.com does not participate, engage with, or receive funding from any affiliate marketing programs or services. To become a free AdvisorCheck member, visit advisorcheck.com/signup