How To Trade A Stock Market Crash - Financhill

How To Trade A Stock Market Crash

How To Trade A Stock Market Crash: Thanks to the COVID-19 coronavirus, we’re living in a state of constant fear of a market crash.

It’s nothing new – for as long as there’s been a stock market, there’s been fear, uncertainty, and doubt. Everything from geopolitics to a natural disaster can cause a market crash. That’s true, but it doesn’t mean the world will end. You don’t have to lose your shirt and sacrifice your retirement.

Even if the market crashes, you’ll still be able to make money. There are plenty of ways to weather the storm, hedge your bets, and secure your financial future. Here are some tips for three styles of traders.

Short-term Traders Surviving the Crash

Day traders are used to playing the stock markets for short-term results. They may make multiple trades in a single day to play the markets right.

So how you can profit from a falling stock market?

1. Buy Puts

A put option is a popular investment when you believe an investment is going to fall.

With a put option, you agree to sell assets for an agreed price and/or at a specific date. It’s especially valuable when the stock value goes down, as you can settle the contract for a massive gain.

Even better, it’s called a put “option” because you have the right, not obligation, to sell. (You “put” the obligation to buy stock at a fixed price on someone else – who gets paid to accept that responsibility; the amount you pay for the put minus the bid-ask spread or slippage).

2. Inverse ETFs (e.g. SH, DOG, PSQ)

An inverse exchange-traded fund (ETF) is created using multiple derivatives. Because it’s an index, you profit any time the underlying investments decline in value.

It’s a great way to protect yourself and profit from a market decline without having to short a stock, which is what we’ll discuss next.

3. Short Selling Stocks

Short selling is a speculative strategy that you’re likely familiar with, thanks to the book and movie The Big Short.

In this advanced investment strategy, you purchase a short position by borrowing shares of a stock and buying it back later at its future market price.

While you can make exponential gains, you can also spend a lot of money holding a short, so it’s not recommended for newbie investors.

Of course, some investors are looking for more long-term investment options. There are strategies for you too.

Thriving in a Market Crash as a Long-term Investor

Long-term investors don’t have the time, energy, or risk appetite for these advanced day trading strategies.

In fact, with many long-term investments, dollar cost averaging is the best way to weather a stock market crash. You’ll often see this happen with your company 401k plan.

With dollar cost averaging, you have a set amount of money to invest in a stock on any given month, instead of a set volume of shares. For example, if you spend $100 per month, and the stock is worth $100, you buy one share at the high. When the value drops to 50, your shares’ values drop in half, but you’re also now purchasing two shares each month at $50 each.

In the long run, this investment strategy works because you’re able to buy more shares at the lows, thus benefitting more when the market bounces back. To pull this off, you need enough expendable income to not only weather the crash but also continue confidently purchasing shares.

The risk of this strategy is you’re investing in a company that never bounces back, like Enron, Countrywide, or Theranos, you’re stuck holding a lot of worthless shares.

Otherwise, you remain oblivious to the market conditions, while continuing to grow your portfolio. If you are holding a toxic stock, you have options too.

Stock Investors Profiting from the Crash

If you’re already invested in a stock that’s going down, you can use call options against shareholdings. A call option is the inverse of a put option. This speculative option gives you the right (but not the obligation) to sell a stock at a predetermined price and or date.

A call option puts the buyer (you) in the long position and the seller in a short position. This means investors can buy a stock at its bottom and continue buying it at that price as it continues going up in price.

Savvy investors use these options to buy rising stocks at rock-bottom prices. Companies that are bleeding cash but still have potential (i.e. Uber and Lyft) are great stocks to use call options on. The best advice I can give you is to remain calm though.

How To Trade A Stock Market Crash: Stay Rational

The stock market is going to crash from time to time. Everybody takes the occasional loss in financial markets, especially when investing over the long term.

But every dollar you lose has to go somewhere. Smart investors follow that trail of money and place their buckets in front of the streams. If you get the timing down, you can profit off the failures of everyone else.

Every high has a low, and every peak has a valley. If you perform your due diligence and understand the underlying operations behind an investment, you can weather any storm.

When the Dotcom bubble burst, massive companies like Amazon and Facebook emerged from the dust. The housing bubble had winners in The Big Short, and even Bitcoin’s bubble spawns an industry of thousands of potentially disruptive companies.

There’s a winner on the other side of every loss, and all you need to do is stand on the right side of history. If you keep your wits about you and invest logically, you can outplay the market just like the Oracle of Omaha.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.