Neither the author, Tim Fries, nor this website, The Tokenist, provide financial advice. Please consult our website policy
prior to making financial decisions.
It is a scary thing to have a vision in your mind of the future state of your stock portfolio, only to see that vision toppled. Thankfully, previous market crashes taught us valuable lessons. After a market crash already happens, it is difficult to filter through all the new stock positioning and react with a clear head. This is why you should think about a market crash before it happens.
Stock Market Crashes are Inevitable
You will be pleased to know that huge market crashes as we’ve seen in March, when Dow Jones plummeted by 6,400 points, don’t transpire very often. A comparable crash to that one happened all the way back in 1987. In fact, it would have been almost identical, with the Dow crashing by 6500 points.
Naturally, when a financial calamity like that happens, new regulations are designed to mitigate the likelihood of them happening again. Thanks to the March crash, we now know those regulations are no guarantee, but nobody knows how many crashes they have prevented. However, we do have some inkling on market crash frequency thanks to Xavier Gabaix, a Harvard economics professor.
Prof. Gabaix came up with a formula, in 2002, that predicts market crash frequency. That gave the formula 18 years to demonstrate its track-record. It passed it with flying colors, as it predicted there would be three instances in which the stock market either rose or fell by 10%. And this is exactly what happened since the unveiling of the formula in 2002 – three such downturns of the S&P 500.
Pandemic Cascade Throws a Wrench into the Formula
A pandemic is one thing, but governments suspending economic activity on such an enormous scale is another altogether. After all, the Hong Kong flu pandemic of 1968 is estimated to have caused between 1 – 4 million deaths, yet no one even contemplated shutting down economic activity that would collapse entire industries, as it happened recently with luxury cruising and movie theaters.
The situation in the United States is further exacerbated by turbulent presidential elections and the uncertainty surrounding stimulus packages and checks. Moreover, as people try to find jobs amidst tens of thousands of perma-closed small businesses, the threat of evictions is looming. Massachusetts alone fears at least 60,000 new homeless people on the streets.
As far as the direct correlation between the March crash and COVID-19 goes, you will find it useful to know that not all stocks reacted the same. We have already noted the stocks that tend to be the most resilient, and that paper aligns with our conclusions completely.
It’s a good idea to avoid stocks that deal with hospitality, tourism, travel, real estate, and many forms of entertainment. At the same time, software stocks, food, healthcare, and natural gas tend to recover quickly and move upwards.
How to Prepare for a Stock Market Crash
Even with a formula holding a solid track record, the current confluence of factors makes it more difficult than ever to tell when the next big crash might occur. Therefore, it is better to place an emphasis on preparation rather than on reaction, despite what some TV and internet personas may tell you.
1. Cut the Weak Links from Your Portfolio
The first thing to do is ask yourself what kind of trader you are: short term or long term? If the latter is the case, your stock portfolio already took into account all the factors that make the stocks withstand market fluctuations. If you’re new to investing and you prefer a hands-off approach, consider using one of the top robo-advisors to learn what a diversified retirement portfolio or fund looks like.
If done manually, many investors favor giant blue-chip tech stocks that are inherently resilient to pandemic-like upheavals. Even if the pandemic is resolved tomorrow, people’s habits of avoiding certain activities will remain for a good while.
2. View Market Crash as an Opportunity
Next, try not to invest all the money you have allotted for stock trading. Make sure to have enough cash on hand — which is already allocated to your investing budget — to “buy the dip”. Market crashes induce panic in many undisciplined investors, who then sell-off stocks that should not be sold. Take heed from Warren Buffet as the most known market player who mastered taking advantage of market crashes.
You likely already have a wishlist of stocks that you would like to invest in, but the opportunity hasn’t presented itself. Keep in mind that a market crash may seem shocking at the moment. Nonetheless, even the last March crash demonstrates that much longer periods of growth follow the steep dips. Take a look at historic graphs of your stocks to mentally prepare yourself to not ditch good stocks.
3. Find Confidence in Professional Traders
There are many stock trading apps, but eToro’s unique CopyTrader feature allows you to copy top-performing traders. You can further minimize the risk by filtering these top-performers by risk score and many other factors. More importantly, you can follow top traders to learn how they react to market upheavals and which stocks they tend to go back to.
Once you have sufficiently diversified your portfolio and gained insight from professional traders, it is important to remember to curtail your immediate emotional reaction. After all, the greatest financial loss in the stock market happens when you sell off stocks that are down. You don’t intend to buy them at a much higher price just to sell them at their lowest price, do you?
✅ Ready to trade stocks? Take a look at the leading stock trading apps.
Disclosure: Tim Fries has no positions in any of the stocks mentioned, and has no plans to initiate any positions within the 72 hours following the publishing of this article. This article expresses the opinions of Tim Fries. Tokenist Media LLC has no position in any of the stocks mentioned, and does not plan to initiate any positions within 72 hours of the publishing of this article. Please consult our website policy for more information.