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Throughout recent history, there have been many (and boy do I mean many) stock market crashes, the most notable ones being the 2020 crash as a result of the Covid-19 pandemic, the 2007 Global Financial Crisis, and the 2001 Dotcom Bubble Burst.
Now, before you start panicking, let us first understand what constitutes a “stock market crash”. Defined as a “rapid and often unanticipated drop in stock prices”, a market crash is essentially an unexpected plunge in market indexes. Although there is no specific threshold defined, a general rule of thumb is a double-digit percentage drop in stock index over the course of a few days.
Market Crash Causes
A stock market crash can be indirectly due to a major catastrophic event, economic crisis, or the bursting of a long-term speculative bubble.
However, the primary contributor to a crash is frightened sellers. When any of the above events occurs, the induced panic selling depresses prices even further, adding onto an already downward spiral market.
Generally, these crashes can be seen at the tail-end of an extended period of a bullish market, where speculations, coupled with greed, have driven the market to unsustainable levels.
Effects of Market Crashes
Evident from the 2020 crash, millions of jobs were laid off globally, and many businesses went into insolvency.
Investors were wary, causing many of them to sell and pull back their capital. Since stocks are an important source of capital that corporations use to manage and grow businesses, this pullback may limit their ability to grow. This in turn leads to retrenchment within the corporations in order to keep afloat. As workers get retrenched or are in danger of being retrenched, spendings in the economy dips due to lesser spending power or workers attempting to save more. This loops back to having a lower revenue for corporations, and the vicious cycle continues, creating a recession.
How to Protect Yourself
1. Periodical Rebalancing
Do not make the mistake of buying your stocks and just leaving it there. It is important to rebalance your portfolio in accordance with changing market conditions. By doing so, you will be able to take note of when stock prices are rising and falling, allowing you to take advantage of this information in order to stay on top of the game.
2. Diversification
This is hands-down one of the most important rules of investing: diversify, diversify, DIVERSIFY. As the saying goes, “don’t put all your eggs in one basket”, this holds true for investing as well. Yes, the tech industry may be booming now, but it is definitely unwise to pour 100% of your money just into tech. As tech is a volatile industry, it is important to include more stable industries like food, or anything to your preference.
3. Hedging
The last step would be to hedge. The purpose of hedging is to protect your investment. There are many hedging strategies out there that you may employ, but for the sole purpose of countering a stock market crash, hedging with gold may be the best bet. As the value of gold will always remain constant, people tend to pour their money into gold in the face of a crash.
Summary
All in all, there are many ways of protecting yourself against stock market crashes, and if you are still unsure of which method will best suit your own preferences, do contact your Financial Advisor for more details!
The methods stated above may not work for everyone, as it depends on your investment objectives, risk tolerance, and financial circumstances, which we may not have information about.
But that being said, I hope that you’ve been able to pick up some weapons to defend yourself against future crashes!
