Times are good in the market right now. However, you can be assured that a big correction or market crash will occur again. Most people who hold stocks for the very long term know that market crashes and corrections are part of life, and shouldn’t adjust their portfolios much — if at all — during these periods.
Others do not have such a time horizon, or maybe they want to position themselves to play off the crash and profit further from it than just staying long. That’s what we in the crisis management business call “having a crisis protocol in place”.
The analogy is rather direct. In a corporate crisis, if you have a protocol in place, you set it in motion and know how to respond because you’ve analyzed the most likely scenarios. The same thing happens with a stock market crash protocol — you want to have portfolio protection.
Companies that don’t have a crisis protocol in place risk looking unprepared, and may even make huge emotion-driven errors in dealing with the crisis — thus make things worse. It then costs them far more to hire a crisis firm to deal with the crisis at the time.
The same goes for portfolio protection. You must know what to do when the market crashes, because if you act on emotion or pressure, you’re going to lose a lot of money.
For those of you who are not sticking with the long-term portfolio option and need portfolio protection, here’s your market crash crisis protocol.
#1 — Sell Speculative Stocks
If you hold any stocks that are speculative in nature, such as companies you think may get bought out, or a company you are taking a flyer on, sell them immediately in a market crash as portfolio protection. You should have a stop-loss in place anyway. If you are speculating, so are a lot of others. These stocks will get hit hard, and you want to raise cash.
#2 — Sell Stocks at or Near Break-Even
Even if you like a company’s long-term story, if you are hovering around break-even with your investment — say within 3-5% — you may want to cut bait and wait for things to turn around in market crash. You aren’t losing or gaining much here by selling, but you want to raise cash and reduce exposure. Again, having a stop-loss in place is a great idea as portfolio protection.
#3 — Retain Big Winners
If you have a stock with a huge gain, and assuming the market crash is not related to the company’s future performance but is more market-driven, then hold. If the story was good before, it will be good again. Consider buying more as the stock dips.
#4 — Short the Market
Thanks to the broad variety of ETFs, you can now jump on board and profit from the market crash. The ProShares Short QQQ (PSQ) lets you short the Nasdaq 100. All those tech stocks will get clobbered, so you’ll want to jump on that. I would also short the broad market with the ProShares Short S&P 500 (SH). Now you are shorting the most carefully watched and popular broad index, all with stocks that are going to get hit.
If you want to really ride the wave of a market crash, you can go super-risky and use the leveraged versions of these ETFs, namely the ProShares Ultra Short QQQ (QID), which gives you triple the short position on the Nasdaq 100. Likewise, the ProShares UltraShort S&P 500 (SDS) triples you up.
Be sure to exit these short positions by setting stop losses or selling out in chunks if the market starts to recover.
#5 — Buy!
You raised cash with some sales and maybe are profiting on the short side. Now’s the time to buy into world-class companies you’ve had your eye on but were too expensive.
Once things calm down, re-evaluate your positions and re-allocate your assets. You may find that you do not buy back into some stocks, but find others on sale. Be smart about your re-entries, and you’ll come out of the crash way ahead of most investors.
Lawrence Meyers does not own shares in any company mentioned.