Image courtesy of Alper Cugun via Flickr.
Economic doomsayers predict market crashes frequently, and though they’re not always accurate, even a stopped clock is right twice a day.
As long as a market crash is in the realm of possibility, which conditions indicate it is, it’s good for traders to know how to deal with it in the most profitable way possible. This way, even if the economy is in the toilet, your wallet doesn’t have to be.
Look for warning signs
The first step to profiting off market crash is being able to spot it before it happens or at its beginning. There are certain clues and characteristics you can look for that indicate an economic crash is at hand.
According to Market Watch, these include:
- Leading stocks fall, indicating market weakness
- It’s September-October, when crashes happen most, markets are most volatile, and traders fearful
- Speculation is rampant, with extreme/unrealistic stock valuations
- Doom and gloom is in the media, making investors fearful
- A catalyst event leads to a downtrend (crashes mostly occur along a downtrend, not at the very top)
The earlier you detect the crash, the better you’ll be prepared to deal with it.
Short sell, or buy on the dip
Many investors say that short selling, or shorting, can be a profitable tactic amidst a crash. Investors do this by borrowing and selling stocks they believe will decline in price, then rebuying them at a lower price to make a profit.
But shorting can be risky and is not advised by all. Instead, market analysts like Michael Sincere recommend traders buy stocks “on the dip” while prices are low, in the assumption that they will soon rise again. Historically speaking, using crashes as an opportunity to buy up stocks leads to higher gains in the long-term.
Not sure what to buy? Go for “shares of good businesses that generate real profits, attractive returns on equity, have low to moderate debt to equity ratios, improving gross profit margins, a shareholder-friendly management, and at least some franchise value,” investment author Joshua Kennon says.
Experts agree that the wrong move, and one everyone tends to make, is to actually sell your shares. It’s like running out of a store when things are on sale.
Buy put options
Another way to profit off a market crash is the preventative route, in the form of put options that protect your investments in case of volatility.
Put options are essentially market drop insurances, which can be bought for a premium and exercised to reap financial benefits if the market does fall. If it doesn’t, though, you could lose the premium in full.
Be prepared, but don’t panic
A good investor will have a diverse portfolio (stocks, bonds, international stocks, commodity investments) that can weather the ups and downs of the stock market, including the possibility of a crash. Revisit your portfolio and tweak it annually, but stick to the course if you want to see gains.
Experts say it’s wiser to let life events dictate your decisions instead of the market itself, as, signs aside, timing the market has rarely worked in the past.
Traders lose money when they let their emotion get the better of them; so for the risk averse, the best way to make money during a crash may actually be to do nothing at all.