Worried About a Stock Market Crash? 3 Strategies to Be Ready
The stock market corrects at least 10% once every 2 years. Major crashes, like the COVID-19 crash of 2020, happen about once in a decade. Now that you can put crashes into context, here are 3 strategies to prepare.
1. Sell Stocks You Don’t Believe In
It’s easy to ride stocks when they are in an uptrend, but it gets incredibly hard to hold onto them when they dive along with the stock market. It’s even more painful when they dive deeper than the market.
Now is a great time to go through your portfolio holdings one by one and evaluate whether they still deserve their spot. I manage a family fund and keep telling my friends to invest in only what they believe in. Wall Street trades the future and so should you.
Here’s what legendary investor Warren Buffett often suggests in his interviews: Write on a sheet of paper why you’re holding a particular company’s stock. Start with “I own XYZ because...”. If, after careful consideration, you can’t tell that story, sell it off and free up the cash.
2. Avoid Leverage Where Possible
It’s tempting to increase your buying power by investing on margin. You borrow money from your broker to buy more stocks. If your broker has a 50% margin requirement, you could technically invest $20,000 with just $10,000 of your own cash.
If the stock rises 25%, you pocket 50%. If the stock drops 25%, your loss is now 50%. Margin interest hasn’t even been calculated in.
Brokers also regularly change margin requirements depending on the market volatility to protect themselves. You may have to liquidate stocks even though you could have held on with the original margin requirements. Margining will only deepen the pain of a stock market crash and should be avoided by most investors.
3. Hedge to Profit During Crashes
Now that we have your house in order, we need to talk about portfolio hedging. Hedging is an underrated skill as far as I’m concerned. Most investors have no idea how hedging works and believe it’s reserved for the upper echelon of hedge funds. Nothing is further from the truth.
You can hedge against market crashes and even profit from them. Anybody can do it and it’s quite simple. The benefits of hedging are two-fold:
- Market corrections are significantly cushioned.
- The proceeds from hedging can be re-invested back into your portfolio at market lows.
All you need to do is pick a futures contract that’s most suitable for your particular portfolio. My portfolio is quite tech-heavy, so it makes sense to use the E-mini Nasdaq-100 (NQ) here. It’s the futures contract on the Nasdaq-100 stock market index. Smaller portfolios can use the Micro E-mini Nasdaq-100 (MNQ) instead. Futures contracts settle daily which means that all cash proceeds are at your disposal immediately.
Published Fri Apr 23 2021 (last modified Fri Nov 04 2022)