At some point the stock market is going to come down. Despite the ongoing optimism which is driving the S&P 500 index to yet new highs, there will come a stock market crash. The difficult questions are when and why, but you can still be prepared for it by researching what you are going to do with your investments during a stock market crash today, before it happens and before the panic takes hold.
One good tip – don’t pay too much attention to what journalists are writing during a major sell-off. Firstly, they have a tendency to wax lyrical, and portray a big bear market as the end of the world. Secondly, there are already many younger journalists working in newswires who will be tasked with writing market news who were still at school during the last big bear market, and who will likely be caught up in all the panic.
What are the options if there’s a stock market crash today
Many savvy investors have made millions by having a bear market investment strategy ready to go in the event of a stock market crash. John Paulson, a New York hedge fund manager, made a fortune for himself and his clients in 2007 by implementing a strategy that would make money from his prediction that the US housing bubble was going to become a wrecking ball in the American financial markets.
But you’re probably not a millionaire, and you’ve probably got active and passive money in stocks. What are your options if there’s a stock market crash today, other than to sell and put it all in low yielding cash or government bonds?
Gold and mining stocks
When fear takes hold and there’s a stock market crash, one place investors go is gold. Gold prices have risen during bear phases in stocks. An easy way to buy gold in the market is to purchase a gold ETF (exchange traded fund). This trades just like a share, but it tracks the gold price, usually either by buying gold futures or actual bullion holdings in bank vaults. Exchange Traded Funds are as quick to buy and sell as physical gold.
On top of that, the shares of gold miners, or funds that invest exclusively in gold miners can do well during a bear market. Take a look at the HUI Gold Index or the Amex Gold Miner Index to see what I mean. It is possible to also buy ETFs that track these indexes.
One of the best precious metals plays in the last large bear market was silver: in 2008 it was trading at around $5-$10/oz. As stocks crashed, it climbed to nearly $50 by April 2011, which in percentage terms was a far better gain than gold.
While we are on the subject of ETFs, it is also worth looking at inverse ETFs. These are exchange traded funds that perform in an exactly opposite fashion to the market. Money will undoubtedly pour into these once a bear trend is established, as they are a convenient way to make money as shares come down.
Most of the inverse ETFs are listed in the US, so you will need to keep an eye on the currency changes between the GBP and USD as well.
However, there are also some ETFs that will allow you to short the FTSE 100. DX x-trackers has a FTSE 100 Short Daily UCITS ETF, while if you are feeling extra pessimistic, ETFS has its GO UCITS FTSE 100 Super Short Strat2X ETF which will deliver twice the downside performance of the FTSE.
Be warned, however, that leveraged ETFs will also quickly lose you money if the market goes against you.
Contracts for Difference
Contracts for difference and financial spread bets can also be useful if you want to make money during a stock market crash. CFDs can be used to trade indexes using a sell order – i.e. you make money if the index drops. These are margin-based products, which makes them much riskier than ETFs, but if you are familiar with CFD trading, then they can allow you to short a wide range of stock market indexes and shares with the currency risk removed.
If you are thinking of trading Contracts for Difference or Financial Spread Bets while you park most of your money in cash during the next bear market, make sure that you have familiarised yourself with how they work, how to manage risk with margin-based products and have lined up one or two brokers in preparation.
Another possibility to make money from your existing shares during a bear market is to buy put options. These are contracts which will let you sell your shares at a specific price rather than at the market price. Unlike futures, there is no obligation to sell attached to an options contract, so if your shares are trading higher than the strike price of the option, you can just let the contract expire.
Put options are more useful if you have large stakes in specific company shares. They work as a form of insurance, so you do pay a premium for owning a put on your stock, but a put option can still give you that ability to sell your shares at a profit (or minimize your losses) if the market is collapsing.
The downside of put options is that they have a limited lifespan, forcing you to renew your put if it expires and your expected bear market scenario has not manifested.
Listed hedge funds
Hedge funds have been having a poor few years of it recently, largely because most good hedge fund managers really only have their best years when the market is going down. Sadly there are far too many hedge funds out there, many have very high minimum investments, and many will go to the wall during the next bear market.
For private investors, however, there is a cheaper way to invest in hedge funds. Several big managers have listed shares in their strategies on the London Stock Exchange, allowing you to buy into them as easily as any company stock.
The more mature funds have traded through several financial crises, and these tend to be the funds you can buy. Big names include Pershing Square, Winton Futures, Brevan Howard and Man Group.
Forex as an asset class is an often-ignored way to make money in a bear market. Profits in the currency trading market are derived from the relationship between currencies and have little to do with where the stock market is going. Trading FX is, however, a high risk strategy and you really need to know what you are doing.
This does not mean you need to exclude currencies from your portfolio strategy. There are numerous ETFs that provide exposure to the movement of specific currencies. You can get exposure to most of the major currencies using ETFs from companies like PowerShares or CurrencyShares. You can also short currencies if you think they are going to fall in value – e.g. PowerShares has a US dollar bearish ETF.
If you can’t make up your mind, there are also G10 currency ETFs which allow you to exploit the carry trade (i.e. currencies tend to go up when interest rates go up). ETFs like PowerShares DB G10 Currency Harvest do just that.
The Armchair Trader says:
We don’t pretend to know when the next stock market crash is going to happen. History suggests that market corrections tend to work in ten year cycles which is why many experts are predicting that the next one is due. However, as we know, the past isn’t necessarily a guide to the future.
There are very few financial markets that are immune to periods of downturn. Long-term investors tend to keep faith in their strategy, choosing to ride out short-term periods of instability or top up their investments where pricing presents additional value.
Short-term investors are more likely to sell quickly and look at short term opportunities like those listed above. As the market bottoms out, short-term investors are more likely to adjust their behaviour, taking advantage of the opportunities that a market correction generally offers.
However you prefer to invest, the most important thing you can do is plan for a stock market crash today. That way, you’ll be ready for any kind of correction.