I hate to break it to you, but trying to position yourself to reap a windfall during a stock market crash will cost you a great deal of your wealth. Instead of taking advantage of trade opportunities, you’ll sit there with your hands tied … waiting. And when the crash comes, you might completely miss out. As John Maynard Keynes once said, “Markets can remain irrational longer than you can remain solvent.”
Waiting on a stock market crash is a bad idea
First of all, timing a stock market crash just right is pure luck. I don’t know about you, but I’d rather not rely on luck when it comes to making money. It’s like not carrying car insurance for 10 years, deciding to buy it one day and totaling your car the next. Pure luck.
Second, a crash is often preceded by a market bubble. Bubbles are fueled by speculation, and they can run for a very long time. Are we currently in one? I don’t know, but it’s not my job to know. My job is to navigate the trade winds and adjust the sails accordingly. I don’t tell the wind which direction it is supposed to blow!
What we can learn from the most recent crash
The stock market crashed in February and March of this year (and in February 2018 and December 2018). Not many traders cashed in on those moves down, because the Fed came in and quickly engineered a turnaround. Suddenly, prices rebounded sharply, crushing the late-moving bears and dragging the skeptics along for the ride. Who wants to be in those shoes? Not me!
Why would you sit and wait for a crash when the market is bullish and there are trades to be had? Protection is inexpensive right now; you can buy index puts to defend your portfolio in case the market suddenly goes south. Because we had index puts on during this recent crash, our Explosive Options portfolio only suffered minor damage.
In mid-February, the bullish sentiment was sky high with markets at or near all-time highs. The VIX was in the low teens, and nobody was looking for downside action. When the crash finally came, the markets fell 30% in a month. It happened far too fast to get on board.
Positioning yourself for a stock market crash is a waste of time, energy and resources. Pay attention to price action, don’t tell the markets what they should be doing and keep some index puts as protection at all times.