From April 2020 to November 2021, the US stock markets went on a surging bull run, with the S&P 500 Index and the Nasdaq Index gaining more than 100% and 200%, respectively. However, since the start of 2022, the market uncertainty over geo-political tensions and interest rate hikes has intensified, causing major stock markets to retreat sharply from their highs.
In fact, at the time of writing in May 2022, the S&P500 and Nasdaq had corrected by roughly 20% and 30%, respectively, putting both indexes in bear market territory. A market correction is defined as a drop of more than 10% (but less than 20%) from its highs. Whereas a bear market is defined as a drop of more than 20%.
It is easier to buy and stay long in a bull market, but it’s a different ballgame when the tide reverses. Furthermore, given the high chance of a global recession occurring within the next two years, are you as an investor prepared for a market crash?
Here are six actions that you can take when the market crashes.
#1 Do Nothing If The Stock’s Fundamentals Remain The Same
“The trick is, when there is nothing to do, do nothing” – Warren Buffett
Sometimes, doing nothing can be the hardest thing to do. If you are holding on to fundamentally sound companies with a strong economic moat, then you could just sit tight and continue to hold them even when the market corrects heavily. This is assuming you have a longer runway to realise the investment and have no immediate need for the capital.
Generally, a well-diversified portfolio of large-cap stocks is able to weather the downturn in the economy better than a portfolio of small-cap stocks. Furthermore, if you have bought fundamentally good companies that exhibit consistently good growth numbers, then you should not be swayed by the negative macro sentiments or by the big drop in price.
Instead, you could continue to hold the stocks and closely monitor their performance to determine if there’s a detrimental change in the companies’ intrinsic factors.
Read Also: Guide To Value Investing In Singapore
#2 Continue To Invest Using Either A Lump Sum Or A Dollar-Cost Approach
The second option that investors have in a bear market is to be a contrarian and add to their current positions.
Assuming again that you had invested in fundamentally strong companies, you could choose to increase your position in the stocks using two approaches.
The first is a lump-sum approach. Instead of investing all your cash at once, you could invest a sizeable amount of your capital at major support levels or at certain percentages of drop. For example, you may choose to first invest 30% of your reserve capital when the market drops by 25% and continue deploying a further 10% of your capital for every 10% decline in the market. This will allow you to capture big declines in the market as you deploy your capital in stages.
The other approach to buying stocks in a bear market is by investing using a dollar-cost approach (DCA). This approach takes away the element of market timing that is associated with lump-sum investing. It ensures that you remain invested in the market for the same fixed investment dollar, albeit giving you more units as the market declines.
The lump sum approach would perform better if the market drops precipitously and recovers in a V-shape, while the DCA approach would perform better in a U-shape market recovery.
#3 Use Options To Hedge Your Long-Term Portfolio
As an investor, you can use options to either boost your returns or as a hedge in a bear market.
Options are financial derivatives that provide the buyer with the right to purchase or sell the underlying asset at a given price for a stated time. While options are only available for stocks listed on the US-exchanges, local investors can use warrants to a similar degree for Singapore-listed stocks.
You can use a varying number of option strategies, but the basic strategies involve buying short-term and long-term put options to capture the downside in a bear market. If the markets go down, you will profit as the price of the put option increases, whereas if the markets go up, your put option could expire worthless, losing the premium you paid.
Another option strategy that can be used is selling a put option on the individual stock. If the stock price goes higher than your option strike price, you get to collect the full premium received for selling the put option. However, if the stock price goes below the option strike price, you may be forced to buy the underlying stock. This is a preferred strategy used by value investors in a bear market as they are willing to acquire the (undervalued) underlying stocks should the strike price be triggered.
While both strategies have their merits, you should only use them (or any other option strategies) after understanding the risks involved.
Read Also: Call & Put Option Trading – 4 Buying & Selling Strategies That Long-Term Investors Can Use
#4 Cut Loss Fast When You’re Wrong And Stay In Cash
You should not think twice about selling (or cutting loss) if your initial investment thesis on the stock has changed or if the fundamentals have drastically worsened. Hanging on to losers will not only deepen the loss suffered but may pose an insurmountable task to breakeven. As shown in the table below, if you were to lose 10%, it would take a gain of 11.11% to breakeven. However, if the loss widens to 50%, it requires a gain of 100% to breakeven.
| If You Lose | Gains Needed to Breakeven |
| 10% | 11.11% |
| 20% | 25% |
| 30% | 42.86% |
| 40% | 66.67% |
| 50% | 100% |
| 75% | 300% |
| 90% | 900% |
If you feel that the overall market sentiments will continue to remain weak and that will affect your holdings further, then you can switch to other highly liquid and safe instruments like money market funds or even Singapore Savings Bonds, until you are ready to enter the market again.
Certain online brokers, like FSMOne, offer a yield of 0.782% per annum (as of 18 May 2022) under their cash management solution. Clients can park their funds in such accounts as they wait for a better time to re-enter the market while earning higher interest than the bank savings rate.
Read Also: [2022 Edition] Complete Guide To Buying Singapore Savings Bonds (SSB)
#5 Profit From The Downturn By Short-Selling
You can also do a short sell of a stock to profit from the stock’s decline in a bear market. Though naked shorting, which is to sell a stock by borrowing from one investor (or the broker) in the hopes of buying it back later at a lower price, is restricted by most exchanges, you could short the market or individual stocks using Contract For Difference (CFD) accounts.
You could open short positions using a CFD account to either profit from the downturn in the stock market or use it as a hedge in conjunction with your long-term holdings.
This strategy could be useful when you are unsure as to how low the market will drop but, at the same time, do not wish to sell your long-term holdings. Similarly, as with options, you should only use CFDs after understanding the full risks involved as they are leveraged products.
Read Also: What Are The Advantages & Disadvantage Of Trading Using CFDs
#6 Reallocate Your Money For A More Concentrated Portfolio
Lastly, you could choose to sell your weakest stock and reallocate your remaining funds to the strongest stock in your portfolio. This will allow to remain invested in the market by reducing your exposure to sectors or stocks that have the least potential.
This strategy could be useful when you continue to hold strong conviction in the fundamentals of a few stocks in your portfolio but do not have much capital left. By selling your weaker stocks, not only will you realise your losses quickly on them, but you will also have funds to buy the remaining stronger stocks at lower prices. This may also improve your chances of breaking even as the stronger stocks recover over time.
Read Also: Asset Allocation And Portfolio Rebalancing: How Often Should You Review Your Investment Portfolio?
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