a Stock Market Crash: Strategies To Survive and Profit
Naturally, investor confidence is the driver, the fuel of the Stock Markets. Naturally, in early 2023, the memories of a difficult 2022 are still very fresh in investors’ minds. Thus, the collapse of two banks over the past week has led stock investors to ask “what is going” on, could this be another 2008 Global Financial Crisis. There has been a drop in expectations, maybe even a slide in confidence. Many commentators and some stock investors have been struck by the seemly fragility of the banking system.
During a stock market crash investors will sell first and ask questions later. That’s the nature of the beast. This can lead to sharp, indiscriminate selloffs. The major stock indexes can drop and drop dramatically. Justified or unjustified, it makes no difference. You may consider some stocks to be or are undervalued. Well, they are about to get more undervalued.
Key Takeaways
- The Collapses of both Silicon Valley Bank and Signature Bank have led to questions about possible contagion.
- When questions swirl about the stability of the financial markets, the likelihood of a drawdown increases.
- Of course, as we witnessed last week, events moved quickly, and one should be prepared for the unexpected.
- The predictions of a recession and the Fed continuing to raise rates, have raised questions about the stability of the Stocks Markets and a possible downturn.
The key is to understand the stocks you own and to focus on the companies that are well funded, solid management will excellent products and services. In a market drawdown, all stocks decline, that’s the market’s systematic risk. The hope is these companies will fall less and recover faster. The objective is to understand and mitigate the stock market’s systematic risk.
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Defining Systemic Risk
The systematic risk of the stock market, also known as market risk, is the inherent risk that affects all stocks listed on the stock exchange. This is the risk that is beyond the control of an investor and is caused by a wide range of factors, for example geopolitical or macroeconomic. These are factors that impact the entire stock market, such as inflation, interest rate changes, political instability, and global economic events. If one of these factors becomes uncontrolable, this could trigger a stock market crash.
Systematic risk is the risk that cannot be diversified away through portfolio diversification. Thus, it is often referred to as “undiversifiable risk” or market risk as all stocks are impacted. The performance of stock market indexes such as the S&P 500 or the NASDAQ, reflects systematic risk. Managing systematic risk is a critical consideration for all investors because it can have a significant impact on portfolio performance.
What is Unsystematic risk?
Unsystematic risk, on the other hand, is specific to a particular security or industry and can be mitigated through diversification. Unsystematic risk, also known as company-specific risk or idiosyncratic risk. This is the risk that is unique to a single company or industry and can be mitigated in a stock portfolio.
Idiosyncratic risk can increase due to specific changes impacting a company, changes in Senior Management, Human Resource issues, and product recalls. These are events that can significantly impact a company’s financial performance, these are examples of unsystematic risk. Because these factors are unique to specific companies or industries, unsystematic risk can be reduced or eliminated by diversifying across companies or industries.
Investors can reduce their exposure to unsystematic risk and protect their portfolio from the negative impact of company-specific events. This primarily done by investing in a portfolio of at least 10 stocks that are from a diverse range of sectors.
5 Key Steps to be prepared for a CRASH
In investing in the Stock Market, the risk of a crash is always there.
Hope for the best, but plan for the worse
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In these Five 5 Steps
Diversification:
Your investment universe should extend beyond Stocks. Invest across a diverse range of stocks, bonds, and other asset classes.
What are Asset Classes and how do they form?
Market Regulations and Securities Laws are the most unifying factor in the formation of distinct asset classes. The most common groups of asset classes are stocks, bonds, cash deposits, real estate, commodities and currencies. As expected, quite diverse. Thus, a group of securities or investments could be considered as an asset class when they exhibit similar features. For stocks an example is the listing requirements.
Cash:
Increasing the cash allocation in your investment portfolio can help mitigate losses during a market downturn. Further, this may enable you to take advantage of buying opportunities post-crash.
Scrutinise:
You must always monitor your stock portfolio, this goes without saying. During periods of possible market turmoil, you must monitor and scrutinise Data and News even more closely. There is a greater need to stay up to date on market trends and economic indicators. Informed investments are always important, but they become critical during these periods.
Remain Calm:
his can be easier said than done, the real objective is to avoid selling arising out of fits of panic. During a market crash, it can be tempting to sell off your investments, but panic selling can lead to significant losses.
Sector Allocation:
Sectors are very broadly divided into Cyclical v Non-Cyclical sectors. Dividing the Stock Market into the different Sectors, assists in understanding sector dynamics and comparing intra sectorial valuations. Focus on the Non-Cyclical Sectors during periods of market turmoil, Utilities and Pharmaceuticals.
Investment Horizon:
A realistic Investment Horizon is a critical part of the analysis, scenario evaluation and decision process, when investing in the Stock Market. An Investment Horizon covers from the short-term, within the next 12-months.
A longer-term is around 5 years. Investing in Stocks requires a realistic time horizon, 12 months is at least a start, more realistic is 2 to 3 years. Have a long-term investment plan. Investing with a long-term mindset can help you weather short-term market fluctuations and achieve your financial goals over time.
Instigate Practical Steps
First: Manage your order book.
As an Independent Investor most of your orders should be “at the market orders”. Do not complicate your trading strategy too much. If there are current orders based on a price target or “good until cancelled orders” cancel these orders immediately.
Second: Raise Cash
This is done by liquidating the more speculative positions in your portfolio. Currently cash deposits are paying a reasonable interest rate. If the stock market does crash, shrinking your stock portfolio will help to minimize your losses.
Third: Look at Writing a Put Options
This Strategy is for the more sophisticated investor and must be done in consultation with your broker. There is the saying in the Options Market, “the way to make money in Options is to Sell Puts”. The process of writing a Put Option involves selling a put option contract to an Investor, probably already invested in the Stock. The Investor has purchased the Right to Sell the Stock under the Put Option should the Stock Price falls below the Strike Price. Thus, the Investor is using the Put Option as part of a Risk management Strategy.
From your point of view, this forces you to sell the stock in order to raise the cash if exercised. As mentioned, deposit rates are better than they were for holding the cash. As part of your analysis in evaluating the stock to target, the strike price is critical. The strike price of the put option must be a price where you are comfortable with holding the stock.
Forth: Raise Liquidity
Maintain liquidity and eliminate any illiquid or even potentially illiquid stocks. Illiquidity should be an analysis which is not limited to only Market Cap. Any sized stock can become illiquid, Nanocap or Microcap Stocks have less volume.
The reality is that, in the worst-case scenario a Stock can become illiquid due to limited interest by other investors. Apart from limited investor interest, the level of volume traded, percentage Free Float and Price Spread are factors. An analysis of these factors is key to identifying illiquid stocks.
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A Stock Market Crash
Stock Market Crashes are viewed in the Mirror
It is important to always be prepared for the unexpected in investing in stocks. Remember unsystematic risk can never be completely eliminated. Even the most diverse portfolios can be impacted by unexpected events affecting multiple companies or industries. Diversification, on the other hand, can help investors manage unsystematic risk and reduce overall portfolio volatility.
Investors can manage systematic risk by investing in stocks from non-cyclical sectors, Utilities and Pharmaceutical are examples. Portfolio diversification, covering a mix of stocks, bonds, and other asset classes is a more expansive approach. Furthermore, some investors may choose to use financial instruments such as options and futures to hedge against systematic risk. It is important to note, however, that managing systematic risk has costs and may expensive.
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