Are Stock Markets Going To Crash Soon? How To Prepare!

Problem

This question is becoming a more and more important issue for most investors around the world at the time of publishing this article, because investors know that as the markets go higher and higher, the sooner and deeper they can fall and then all their patiently built up PAPER profits might evaporate in a short matter of time; throwing back the majority of investors – of whom by far most usually follow the conveniently simple and lazy so-called buy-and-hold strategy – years back in time on ancient price levels, needing many years again to recover and be in profit again or to be able to continue growing their capital from where it was. And as every investor knows: all bull markets are followed by market corrections, resulting in bear markets (down trends).

The problem is: nobody knows or can predict how high the markets can go for how long or how deep they can fall, which makes the concept of Buy Low, Sell High practically impossible to achieve, because simply nobody can predict the future of the markets. And another reason why it would be wiser to use another strategy than Buy-and-Hold: in the last 100 years it happened twice that stock markets needed 30 years to recover from a major correction! So it is not unusual for markets to take so long to recover. Who can risk so many years of no-profit making to be able to grow capital?

Analysis of Current situation and statistics

So where are we now and what can we learn from the past (although we know that results in the past don’t guarantee anything for the future)? The last major correction has been in 2008-2009 during the Financial Crisis, where most stock markets fell more than 50% on average (based on US market collapse, followed by many other country indexes). Most stock markets have been recovered ever since and now reaching, in many cases even touching all time highs. Historically seen on statistics the bull-bear-market cycles is as follows:

– The average period between stock market corrections is 4-5 years
– In those periods the corrections are on average between 35-40% or even more (like in 2008-2009)
-The longest period of a bull market cycle has been 8 years.

This means that we are already breaking a bull cycle record soon. Although these are just statistics representing results from the past and it absolutely doesn’t mean that it has to repeat in the same sequence in the future. The stock markets can just as well break new records by time and price level, although eventually followed by a correction anyway. As we have already seen: we really can’t predict any of that.

On the other hand every other investor that has his money in the stock market also sees these facts and many might already have good paper profits which they might wanna take before another correction occurs. Because of higher prices and the length of the cycle also fear might play it’s role and many investors might get more and more fear of hights. This means that every major negative news event might trigger more profit taking and sales out of fear of loss, by that causing domino effect and a new major correction might occur much easier than before. Or it might not happen and stocks rise to even greater hights.

How to prevent losing those many years of capital growth building that (mostly buy-and-hold-strategy) investors have to take by suffering huge losses after major stock market corrections? Are there any solutions? How can we prepare ourselves in case indeed a major correction might happen sooner than later? In this article are hopefully some guidelines for a bit more intelligent view on investment management than the mainstream buy&hold strategy:

General Market Analysis

First of all let’s differentiate all directional conditions that the stock market can have. And there are only 3 possibilties:

1. Bull market: the market prices are in an UP trend; prices are rising
2. Bear Market: the market prices are in a DOWN trend; prices are falling.
3. Neutral Market: the market prices move in SIDEWAY trend; stock prices move within a certain band.

Another important thing to know is the following:
– Bull markets first go to neutral before going to Bear and vice versa!
– A neutral market will eventually EITHER turn into an uptrend or turn into a downtrend!

Besides these 3 directions there are no more possibilities! So if we can determine in which condition the market is AND if we can apply a specific strategy for every specific condition, we will need to form 3 strategies that are in line with the market condition. That way we will have better chances of survival, no matter where the market will go, because we will adjust our investment portfolio accordingly.

Solution for investors

So from the analysis above we can conclude that the solution for dealing with every market condition INCLUDING market corrections during bear markets would be the following method:

1. Define the rules on how to determine in which trend the market is at every current point of time.
Although it is up to every investor to make his own decision on how to look at the market condition in collaboration with his fund manager or investment advisor, here are some helpful guidelines:

Usually trendlines made from Moving Averages are used to see the current trend of the market. For the type of strategy discussed here, a weekly period would serve the purpose of looking at the trend over a longer period of time. The moving average will show the direction of the market: uptrend, downtrend or sideways. Up or down trend are usually easy to determine; for a sideways trend one can choose an indicator to show the zone within where the investor decides that there is the neutral market if the prices stay in that zone. An indicator that could serve for that purpose would be Bollinger Bands for example.

2. Define the rules on how to act in every specific market condition (only 3 possibilties, thus only three possible strategies).
Also the rule setting should be done with the advice of your fund manager or advisor. To give some guidance in this process, here are some views per market condition:

Bull/Up trend:
If the trend is in a bullish uptrend the preferred way would be to buy heavily in growth stocks of blue chip companies with outstanding results. Your investment advisor should be able to help with stock selection or determine the rules of selection of stocks that will be bought during the first period of the up trend. The full potential (up to 95%) of the cash capital should be invested in stocks step by step over a number of weeks.

Neutral/Sideway trend:
If the market comes into a neutral market zone, the best strategy would be to transform the position to as much cash as possible, preferably increase to 75-90% cash position, by selling most of the stocks and by that securing the profits. Best way is to sell more of the falling stocks in the portfolio and less of possibly some (contra trend) rising stocks. In the neutral zone we can take our time to look out for next investment possibilities for when the market becomes bullish again, but we won’t buy until an uptrend is actually confirmed happening. Also we can discuss with the investment advisor and prepare some possible bear market strategy options to apply for when the trend becomes bearish.

Bear/Down trend:
The main thing in the bear market is to avoid LOSING money and there are 2 choices to achieve that:
First option is to do nothing and stay in a large cash position; you won’t risk losing a lot of money, but it will also not help growing your capital; anyway it could be a fair and save way to go.
Another option is to apply bear market strategies to benefit from falling market prices for hedging the still existing small portfolio of stocks and/or even make profits from the down trend. There are several strategies available with different risk profiles. An investment advisor should be able to give guidance in the decision making and risk assessment.

3. Stick to the rules set in number 1 and 2!!
If adjustment of the rules seems necessary, it should best be done after a trend cycle! Analyse the previous cycle and make adjusted rules for the next time the same cycle appears.

Prepare your strategy for major future events NOW

Since we can’t predict the future, at least now there is a method to follow to act in line with a current market condition and by that skipping most of the losses that in the past we had to suffer by not knowing what to do at what time in the market. Especially now will be the time that major things can happen: either a massive continuation of the bull trend for an extended period of time OR (and this seems to be more likely looking at statistics and market psychology: ) a major market correction following any type of crisis that triggers it. So it is strongly suggested to investors, especially those Buy&Hold investors, to form your own personal method with rules for all 3 different market conditions, so you’ll be prepared for any scenario that the future will present and can benefit greatly from it! Good luck and a lot of investment wisdom to all!

DISCLAIMER

The above references an opinion and is for information purposes only. It is not intended to be any kind of investment advice. Seek a duly licensed professional for any investments to be made at any time under any circumstances. Do not make any investment or take any action into investing without the advice of such a professional.