Stock Market Crashes … what should I do?

You would be forgiven if you are one of the millions of people glued to news headlines, computer screens or have your phone poised with your stock broker on speed dial. With the global markets in the midst of a major correction, tens of Billions of dollars have been wiped off the board!

But the most important factor is what you should be doing. How can you evade making losses and how can you profit from the fear that is driving this correction? Before we answer this, let’s first take a look at how the markets have reacted during previous crashes, and what the best course of action was.

There are many documented crashes (or corrections) in global markets over the last few hundred years. Even before the stock market was a governed entity, crashes such as the Dutch Tulipmania (1637); the Mississippi Company (1720); the British South Seas Bubble (1720); and the more recent Great Depression (1929), created fortunes but then bankrupted tens of thousands of investors, crippling countries and reverberated globally.

Hindsight is a wonderful thing, but is only helpful when investors/traders use the lessons learnt to take action in the future. And this is the first lesson to be learnt:

1)     Protect before the crash occurs.

Typical market activity provides us with signals that there is weakness well before actual crashes hit the markets. This could be a Technical indication on the chart or even the release of economic data that changes the outlook for the markets.

Any investor who does not utilize derivates for protection when there are signs that the markets are faltering, is doing themselves a dis-service. In the Investor Chronicle, we adopt Put Protection for investment portfolios and in the more recent global debt environment, have proven that this type of protection is well suited.

If you’re not confident in making the decision when the markets are heading towards a risk period, then we suggest adopting a Full Service broker who has proven results during such periods.

The chart on the right is the ASX200 representing a strong market correction prior to the GFC (Global Financial Crisis) that occurred on the16 Sept 2008. Market panic occurred on the 22nd Jan 2008 (the price activity on the right of the chart), marking the 12th straight losing day, and wiping out 1,120 points or 17.7% during that period.

ASX200

Following this, the markets consolidated in a wide range between 5,100 and 5,900 before establishing the 2008 Bear market.

In the next chart, we have highlighted the actual GFC market crash amidst the Bear market. As we can see, it is a minor price movement compared to the greater downwards trend. But it still created a great deal of fear amongst investors despite the fact the markets were in a steady downwards trend prior to the Sept crash.

Sept Market Crash

The second lesson is:

2)     The day that the markets panic sell and drop 4, 5, 8% or more is not the day to be selling your shares.

If you’ve missed the opportunity to adopt protection or close out of your positions and you find the markets are receding, then don’t follow the crowd and panic sell. If you have chosen your investment positions wisely, then in most cases you will find the stock prices recovering in time.

How soon stock prices recover is an unknown factor. It mostly depends on whether it is a one-off negative market reaction, or if it is the catalyst of an economic recession. For example;

  • 6th May 2010 Flash Crash: On this day, the US markets panic sold on supposed electronic trades or an order error triggering automatic trading systems. The S&P500 index fell 99 points or 8.5% during the day, recovering to close 36 points down or 3.1%.
    As the following chart shows, there was a recovery in the sessions following and over the longer-term failed to produce a Bear market and in fact the markets rallied from Aug2010 through to the peak in early 2011.
Flash Crash
  • August 1998 – Asian Currency Crisis: In the following chart, the Asian Currency Crisis created a panic reaction around the world. The S&P500 fell 70 points on the 31st Aug 2008, or 6.8%. Following this movement, the markets consolidated and then continued in the Bull market trend.
Asian Currency Crisis

In both of these examples, the panic selling periods didn’t turn into long-term Bear markets. But in these scenarios, global economics were sufficient to instil confidence in investors. The ‘flash crash’ scenarios merely created new opportunities to buy stock at relatively cheap prices.

Looking at the here and now, we certainly have a much weaker broader scenario. It is more consistent with the build-up to the GFC (2008) or Tech Wreck (2000) which resulted in Bear markets.

  • Economics – Both US and Australian economic data is showing weakness. The US beginning to show strong potential to denote a Recession.
  • Markets – ASX200 is clearly in a downwards trend. US indexes have retraced to break support levels
  • Sentiment – Market volumes have been extremely low over recent months, increasing with the downwards break. There is a great deal of cash on the sidelines reflecting a lack of confidence in the markets. In recent trading sessions, investors have also been increasing investments in lower risk medians such as Gold and US Dollar
  • Fundamentals – the US earnings season produced mixed results. Starting off positively, we have seen much weaker results in the last week. Australia is now at the beginning of earnings season and we are expecting soft results following the impact of global natural disasters

Our view of the current situation is that there is a greater probability of the markets remaining soft or weaker over coming months. Although Australia is expected to show mild GDP growth, it is not likely to reflect the same in the markets.

Hence, investors should be adopting a defensive portfolio approach with protection strategies. But remember, the downward slide will eventually come to an end with good sound stocks trading at very attractive prices.

Every Bear market offers opportunities, and it is those who don’t panic that win in the end.

 

 

Since 1998, Matthew has been involved in the Financial Services industry providing stock, option and CFD advisory services, trading advice, funds management and education services. Matt is an Authorised Representative of Halifax Investment Services, providing analysis and recommendations for trading Covered Calls in the US markets and using Exchange Traded Funds (ETFs) ...
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