From soaring asset prices to rock-bottom lows, anything could happen in a volatile market.
Although stock prices have always eventually bounced back, there’s no telling how long the dip will last. As such, you should always prepare for a market crash as an investor. This is when stock prices dive because of sudden negative events such as a natural disaster, an economic crisis, or political unrest.
But if you act rashly during a market plunge, you might lose all your savings or miss out on an investment opportunity. Fortunately, you can take measures to protect yourself from a crash. Here’s what to do when the market drops.
Do Nothing!
Panic selling is a natural reaction when the market dives. However, you lose sight of your investment goals when you trade emotionally. Acting on impulse also increases the risk of errors when interpreting facts and figures. Note that upturns often follow downturns. Sitting tight during a crash prevents losses in the long run and might even increase your portfolio’s value when the market recovers.
On the flip side, selling on a downturn triggers revenge trading in the rush to regain losses. But instead of improving your position, revenge trading worsens your deficit when you make uncalculated moves. Such losses might affect your confidence, bringing doubt to every move. You might even stop investing altogether. According to a recent paper, Over 30% of the traders who panic-sold after a downturn exited the market completely!.
Buy the Dip!
When the market falls, buy more! That’s what “buying the dip” means.
The strategy works best during a sharp market decline with a strong signal of an upturn. By getting high-value assets at a bargain, you fulfill the investment principle of buying low and selling high. However, don’t buy everything; some equities are more profitable than others.
For example, you can invest in volatile sectors such as tech, commodities, and communication. You could also try growth stocks that focus on innovation, research, and development.
Another strategy is buying the leading stocks in a collapsing industry. If an entire sector falls, you have a better chance with its top two stocks than the poor performers. Alternatively, you can own a stake in multiple companies by purchasing sector ETFs. You could also limit how much you invest. For instance, you can set a 20%-decline threshold instead of waiting for a further drop. Most importantly, recognize your biases. The rush to get a deal shouldn’t cloud your objectivity.
Hunt for Dividends!
When buying stocks during a crash, you want to invest in reputable, large-cap organizations with solid balance sheets. In addition to their low volatility, established companies have a history of increasing dividends.
This way, earnings are guaranteed even when prices are tumbling. Furthermore, dividend stocks offer peace of mind to improve your composure when making trading decisions. You’ll think twice about selling during a crash if your holdings generate income.
At the same time, you could reinvest the dividends instead of taking the money. Although it disrupts your cash flow, you benefit from compounding when you reinvest dividends. These dividends purchase more shares, increasing your bonus the next time
Remember, the decision of whether or not to reinvest dividends depends on your finances. If you have a dependable income and no pressing commitments, reinvesting dividends is not a bad idea. However, you need cash to cover living expenses if you’re approaching retirement. On the other hand, reinvested dividends have time to grow as a young investor.
Dollar-Cost Average!
Everyone wants to buy low and sell high. However, you won’t always time the market successfully during a market crash. For instance, you might buy the dip before a stock hits rock bottom. If your money remains idle in a bank while you await a further price drop, you could miss out on compounding returns.
Dollar-cost averaging divides a lump sum investment into periodic purchases. Assuming you have $100,000, you can split the amount over 10 months instead of buying stocks at a go. This long-term outlook prevents the panic selling that comes with a brief market dive.
Likewise, dollar-cost averaging helps you get more shares at a bargain during a downturn. You enjoy automatic dollar-cost averaging when investing through workplace retirement programs. Conversely, you can automate your contributions when investing through an individual retirement account or taxable investment accounts.
Though you should know how to act during a market collapse, planning for a crash preserves the investment and increases your financial resilience. Anticipating the downturn also reveals your risk tolerance to prevent psychological and financial effects when the market takes a dive. Remember, a crash isn’t permanent. The market will probably recover no matter how long it takes.
It always has!
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