Pain, suffering, panic, confusion, loss of property, loss of money, fear, doubt. These words seem to be describing an automobile crash and yet can also be applied to how an investor might feel after a stock market crash.
A stock market crash is a sudden drop in stock prices (usually a double-digit percentage decline) in a brief period of time. This differs from a Bear Market which sees stock prices fall over a longer period, usually months or years.
The good news is that just as you can take steps to protect yourself from an automobile crash with regular maintenance and insurance, the same principals can be applied to your investment portfolio to protect yourself in case of a market crash.
Understand The Causes Of A Stock Market Crash
The key to avoiding losses during a stock market crash is to study the history of market crashes, and figure out what lessons can be learned from the circumstances surrounding each crash.
Although each market crash was the result of different events and circumstances, they were all following periods of exuberance and wild speculation in the market.
Whether it was the over-use of leverage, or exposure to risky, complicated financial instruments, history provides important clues to protecting your portfolio from an unexpected and expensive market crash.
The crucial aspect to keep in mind when studying stock market crashes is the role that fear and emotion play. While certain fundamentals may contribute to a declining market, a crash most commonly occurs when panic selling sets in, and crowd mentality takes over.
This highlights the importance of keeping a cool head, and making rational decisions even when others are not.
Insure Your Portfolio Against A Stock Market Crash
While a stock market crash may be inevitable, loosing everything you have in one is not. There are some simple steps you can take to cushion your potential losses, and even realize returns in almost any market.
The most important step you can take to prevent devastating losses to your investment portfolio is to educate your self fully on every stock you own, the sectors as a whole and economic and political influences on the market.
While not always the most glamorous of tasks, educating yourself is the single best thing you can do to hedge against risk, and mitigate losses.
It is also crucial to establish a plan and stick with it. Use limit and stop-loss orders to keep losses and costs to a minimum, and maintain a balanced portfolio that contains an age-appropriate mix of stocks and bonds.
In addition to owning government bonds for the purpose of hedging against risk, you can consider investing a portion of your capital in precious metals, another traditional form of portfolio insurance.
While there is no insurance against loss in the traditional sense, these strategies can greatly decrease your losses and even help you realize gains in a volatile market.
Always consider your unique financial situation, risk-tolerance, and time frame for investing when developing and implementing an investment strategy.