“What to do in the event of a stock market crash” ask investors who have not been able to anticipate the panic-selling. “How to make money with the collapse of the stock markets” ask those investors who see the sell-off as an opportunity to increase their profit when all the others are running away from equities.
I was not entirely honest in the title of this article, I admit it: I will describe Warren Buffett’s 3 tips to make money if the stock markets collapse, but I will also try to explain how to make money with CFD trading in case of market crash and you I will give three general indications for reacting to such an event. But first let’s try to understand what “stock market crash” actually means.
Stock market crash: what it is
There is no precise definition of a stock market crash (or stock market collapse). The most famous stock market crashes in recent history are the Wall Street crash of 1929, the Black Monday (October 19, 1987), the Nasdaq crash of 2000/02 (the “dot-com bubble”), the stock market crash of 2007/08 due to the sub-prime mortgage crisis: three different events in origin and effects, but from which common elements can be drawn to define – and, if you think it possible, predict – a market collapse.
A stock market crash occurs when, due to a sudden drop in the markets, the gains made over the last few years are burnt. In a few weeks or days, even in a few hours or minutes, billions of capitalization are burned and the price of many shares plummets to very low levels.
The immediate effect of an initial stock market crash is… a further market crash. In fact it is well established that panic brings with it terror and therefore, in the face of a sudden collapse of the stock markets, investors will be easy victims of fear. A vicious circle will therefore be created with a further collapse, another billions of capitalization burned and then an even stronger decline.
In the end, from the stock market collapse there will be a real markets collapse!
The media often speak of a stock market crash even if, more often than not, the falls in the indices remain below 5%. These are “crashes” in relative terms because, historically speaking, real stock market crashes are much worse.
For example, speaking of the dot-com bubble, in the first phase the Nasdaq index began to grow disproportionately, reaching 5,048.62 points on 10 March 2000. This was the maximum peak reached by the Nasdaq since, starting from the following days, it began a collapse that brought the index to a minimum of 1,221.09 in the session of September 20, 2002. In less than two years the Nasdaq index had lost 75,8% of its value.
Is a stock market crash possible today? Absolutely yes, the stock market crashes have always been and always will be. It is true that by analyzing the history it is possible to predict when there could be a new collapse of the market, however, as shown by the past, each case is a story in itself. Of course there is experience but it will never completely eliminate the risk of a stock market crash.
Some static data can help to understand why it is better to be aware that the stock market can always collapse and enter a phase of prolonged sell-off.
According to Morgan Stanley, from 1988 to 2015, there were drops of 5% on average every two times a year. These sell-offs lasted on average 67 days. Collapses of more than 10% occurred every two years and lasted 170 days on average. Collapses of over 15% occurred every 3 years and lasted 255 days, while real crashes of over 20% occurred every 6 years and lasted an average of 465 days. Yes, a stock market crash is still possible.
Warren Buffett’s tips for making money if the stock market crashes
Only experience helps the investor to be active, not passive, in the event of a market crash. Successful investors don’t make money (only) with the help of luck, continuous study is required to make money if markets collapse.
Warren Buffett is known to follow three rules in the event of a stock market crash. Warning: the three tips that Buffett usually gives to prepare for a market collapse are not operational but theoretical. They are general advice, therefore, which must be concretized in trading choices and strategies by investors.
Warren Buffett’s first rule for preparing for a stock market crash
The first advice Warren Buffett gives to prepare for a possible market crash is “buy when the blood is on the streets”. Behind this sentence there is a very simple advice: buy when everyone sells, then buy at low prices by betting everything on an increase that will inevitably take place in the long term.
When the dominant trend is bearish, good deals can be made. Obviously translating this advice into facts is not for everyone and it takes a good preparation and knowledge of the financial markets, but also of oneself to maintain control.
Warren Buffett’s second rule to prepare for a stock market crash
The second advice that Warren Buffett gives to prepare for a possible market crash is “spend only and exclusively what you can lose”. In other words, the oracle of Omaha invites us not to waste money on investments that we cannot do without, but to spend only what we can also lose. This tip is very close, in meaning, to another rule that Buffett often mentions: “don’t borrow money to buy stocks”. Never!
But why does Warren Buffett recommend spending only what you know you can lose? Behind this advice, very useful in the phases preceding the market crash, there is nothing ethical and there is a lot of practicality. The debts made to invest must be repaid (and quickly too), but it may take too long for the crisis to end. Borrowing to invest is therefore not sensible.
Warren Buffett’s third rule to prepare for a stock market crash
Buffett’s third advice for preparing for a stock market crash is perhaps the most important: “trade knowing that a crash will come but not knowing when that crash will come”. In other words, it is necessary to be aware that the market’s bullish phase cannot be eternal and collapses are part of normal stock market dynamics, but it is not possible to know when they might arrive.
This is the teaching that the Omaha guru seems to give to all investors, stock market crashes will always exist and can be a profit opportunity. After all, it is no mystery that Warren Buffett’s company, Berkshire, has always followed this investment strategy: investing in shares that pay high dividends even in the down phases, with the aim of aiming for the payout.
Stock market crash: earning with CFDs
You can profit from stock market crashes with Contracts for Difference. With CFD trading it is possible not only to earn in the event of a rise in the prices of stocks and indices but also in the event of a fall, by opening short positions.
I don’t write online trader reviews with the aim of getting you to sign up through my link and take a percentage of your first deposit, on this topic so far I have only written this practical guide: Investing online with CFD trading.
I recommend taking CFD trading into consideration to try to make money when the stock market falls sharply. In fact, CFD trading allows you to open short positions and therefore speculate by betting on a decline in both indices and stocks. In these situations, the advantages of CFD trading are considerable because trading Contracts for Difference will not actually sell stocks: CFD trading, in fact, is a “bet” on the performance of a derivative that reflects the price trend of indices and individual shares.
Stock market crashes: three practical tips
I hope I have made it clear that stock market crashes are quite common events in history and that it is still possible to earn with them, the question to ask at the end of this examination is whether there are practical tips to get out of the crash without damage, with capital still in your pocket (as far as possible). There are three rules for surviving the stock market crash: reflection, planning and implementation.
Thanks to reflection it will be possible to evaluate the soundness of your investment. In particular, if you are panicked it means that you have not been able to build a low-risk investment portfolio. The design phase is the inevitable outcome of the reflection phase. A good reflection on the errors present inevitably leads to the design of a new wallet.
Finally, after designing the investment portfolio, all that remains is to move on to the implementation phase. Attention, because it is at this stage that it is necessary to calculate the right timing, that is, to evaluate if and how long the stock market crash will last. The risk is to act too quickly and therefore miss an important opportunity to make money with the stock market crash.