Right now as I write this post, global stock markets and cryptocurrency markets are in the midst of a market crash. Prices have been plummeting for days, even when the overall market has been going down for almost 6 weeks. During these extremely bearish conditions, what should you do with your portfolio?
You could continue to hold your assets as the prices drop in the hopes that the price will rise again at some point in the future. This is usually a safe approach, but it can be extremely nerve-racking to do and can sometimes take years to see a full price recovery. Should you drop out of the market or buy the dip to increase your exposure to the market? Ultimately, the right decision should be based on your level of risk tolerance and when you think the bear market could come to an end.
High Risk, High Reward Market Crash Strategies
If you’re willing to engage in risky behavior to have a chance to earn very high rewards, a market crash presents the perfect opportunity for this strategy. At some point during the price corrections, the market will bottom out and reverse. If you can time this correctly and buy assets at their low prices, you stand to earn a significant profit as the price rises again. The only problem with this tactic is that it can be very difficult or even impossible to accurately predict the bottom, so you may buy and prices continue to drop.
If you know the usual prices of the stock or crypto you want to buy, you may be able to take an educated guess when to buy. You don’t necessarily have to successfully buy at the lowest possible price, but you do want to buy at a price that is unlikely to stay that low forever. As long as you buy low enough, you should be able to wait out the market until it recovers to sell at a much higher price.
Some people will attempt to wait until the market recovery has begun and then pile back into the market. Sometimes this can work great, but it also ensures that you’ll miss some of the potential profit since you won’t buy at the lowest price with this tactic. Recoveries can also be deceiving since the market can appear to start recovery and then quickly reverse again to begin another nose dive.
Cut Your Losses For Low Risk
In the past 6 weeks, the S&P 500 is down about 15%. During that same time period, Bitcoin is down about 30%. Ethereum and other crypto markets are down similar amounts, although some altcoins are down much more than that. These price drops didn’t happen overnight – it’s been a fairly slow and steady decline over these six weeks.
Many people won’t have the tolerance for risk this high. It is okay to sell everything to cut your losses and drop out of the market for a while, especially if you are fairly confident that the prices will continue to drop short-term. When you sell at already low prices, you’ll likely take a loss on your trade. However, you may be able to limit your losses this way if the prices continue to fall.
The thing about corrections and bear markets is that they have to end sometime. After a huge correction like the one that has played out recently, you’re almost guaranteed to get an opposite reaction when the market finally does turn around. Eventually the prices reach a low enough point to be a very attractive buying opportunity for everyone and the market quickly rebounds. If you miss this rebound, you miss out on most of the profits this bear market had to offer.
Dollar Cost Averaging
For anyone that has additional funds to invest into their portfolio, a bear market can be a great opportunity to add to your holdings and reduce the average amount you’ve paid for each share. When you buy a share of stock for $100 and then the price drops to $50, you can buy another share to reduce your cost per share from $100 down to $75 – one share for $100 and another share for $50 averages out to be $75 per share. If you bought three new shares, you’d have a DCA of $62.50, so you can continue to reduce this average amount lower the more shares you buy.
When your portfolio is at a loss, you can make it easier for yourself to become profitable by purchasing additional shares for lower prices to reduce your dollar cost average. Using the example above, that stock that has dropped to $50 will need to increase by 100% for you to break even at $100 per share. If you dollar cost average your way down to $62.50 per share, you only need the stock to recover 25% to break even and you’d have a $150 profit overall if you waited for the price to return to $100.
Only one thing prevents this strategy from working – the price doesn’t go back up. If someone had used the DCA, dollar cost average, strategy on stock for Sears over the past decade, that would’ve been a pointless approach that only resulted in losing even more money because the price never recovered and probably never will. By continuing to invest even more into a losing portfolio, you need to be extremely confident that the prices will go back up eventually or else you should cut your losses and get out while you still have money left.
When your entire portfolio is already invested and you don’t have additional funds you can or want to invest, you won’t be able to use DCA to lower your cost per share. In this situation, if you are very confident of a bear market, you can make a riskier play to sell your entire portfolio, wait for prices to drop more, and then invest your portfolio cash again at lower prices.
When timed correctly, this can work out great to increase the number of shares you own without increasing your investment. However, if you end up selling at the bottom, you can simply lose more money this way and may miss out on the sharp recovery that usually follows the bottom of a bear market.
Option Puts / Calls
For full disclosure, I don’t personally short stock or crypto. I only buy assets to hold, so I don’t use options either. For anyone that does option trading and is familiar with it though, you can utilize options to reduce your risk in a bear market if you also own assets.
The general strategy involves buying put options for the same assets you own when you suspect a bear market is on the way, so this approach would’ve been useful over the past 4-6 weeks. You own assets that you don’t want to sell but you also suspect that the price will likely drop soon. Owning the assets is a bet that the price will rise, so you can then bet against yourself to balance out your results.
While this strategy is a hedge against risk, it also creates more risk if you’re wrong about the impending bear market. If the prices continue to rise, you’ll lose the money from your options, which will eat into the profits you would’ve made owning the asset. For this reason, I highly recommend avoiding this tactic if you’re not experienced with options. In my situation, I’d be better off selling my assets instead of dabbling with options.