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What should you do during a stock market crash?

First of all, it’s important to understand that the vast majority of the time, crashes come in the context of bear markets. The 1987 crash is one rare exception and occurred during a bull market (note I’m not counting “mini-crashes” here, such as 2010, but only true large-scale crashes).

Once you understand that crashes virtually always come during bear markets, the next thing you need to understand is that there are two types of bear markets:

  1. Cyclical bear markets: These are relatively short-lived bear markets that occur in the context of a much larger bull market. Examples of cyclical bear markets are basically every bear we’ve seen since 1982, including the tech crash of 2000, and the 2008 crash during the financial crisis. Cyclical bear markets end on V-bottoms and launch right back into bull markets (most recent example: the 2009 low).
  2. Secular bear markets: Secular bear markets are sometimes called “generational bear markets.” Secular bear markets can last for many years; even decades. Examples include: 1906–1921; 1937–1949; and the most recent being 1968–1982. Secular bear markets do not end with V-bottoms, they die on total indifference. By the time a secular bear has run its course, NOBODY wants to own stocks anymore. Stocks are universally perceived to be a horrible investment, so nobody cares when a secular bear ends, and most people don’t even notice.

Those of you who own digital watches will immediate realize one important fact:

No one who started trading/investing after 1982 has ever seen a secular bear market.

This is why you’re getting advice on this question such as “Don’t sell in a crash!” “Be sure to buy the whole way down!” “Stocks always come back for the long haul!”This advice is spoken by people who have only lived through cyclical bears, in the context of the much larger secular bull market that began in 1982.

And it’s really, really dangerous advice.

Imagine if you took this advice in 1968, and started buying as the market began tanking. If you “bought the whole way down,” you would be underwater until the 1990’s. I don’t know what sort of time horizon you have, but most people aren’t prepared to sit on losses for 20+ years. You could be dead by the time you break even.

Take a look at the chart below, with a focus on the bear markets. I don’t consider 2000–2009 to be a true secular bear, because the price high of 2007 exceededthe price high of the year 2000 on both the Dow Jones and the S&P.

secular bear market

It is worth noting that, on an inflation adjusted basis, if you bought in 1906, and later missed your brief opportunity to sell at a profit in the late 1920’s, then you didn’t break even for nearly 50 years. It’s pretty dangerous to be “buying the whole way down” when that type of market shows up.

So, what should you do during a crash? Well, that depends on how good you are at timing the market. (I do get quite tired of hearing certain people confidently proclaim that “you can’t time the market.” Those people are deeply misguided. THEY personally can’t time the market, obviously. But their inability to do something does not mean it cannot be done at all. The market most definitely can be timed.)

If you were good at timing the market, though, then you probably wouldn’t need to ask this question in the first place.

So my first advice is to start educating yourself on how to read technical patterns. Everything the whole world knows, collectively, about a given stock is revealed by its price chart. Everything. Therefore everything you need to know is in the price charts. I would highly recommend you learn how to read charts, even if only on a basic level.

Once you understand how to read technical patterns, then you will have an idea of what sort of downside potential is present during a crashing market. You’ll be able to arrive at rough price targets, and will thus at least know enough not to start buying willy-nilly, literally at random (blows my mind that some people do this).

If you’re dead-set on holding all your positions until they’re deeply underwater, then you can help protect yourself by hedging. One simple hedge for a net long portfolio is index put options. Put options increase in value as the market goes lower. During a crash, put options can easily gain 40–200 times your original investment, so a little protection can go a long way.

So that’s my advice:

  1. Learn how to perform at least basic technical analysis.
  2. Learn how to hedge your portfolio.
  3. Do NOT start buying randomly during a crash, because you can easily lose 50–100% doing that. And keep in mind that even a 50% loss subsequently requires a 100% gain just to break even. If the crash comes in the context of a larger secular bull market, granted, the market will bail you out eventually (presuming you can afford to be underwater indefinitely and don’t need the money).

The bottom line is that there’s a reason for the old saying: “Don’t confuse brains with a bull market.” Everyone who bought during the 2008 crash thinks they’re a genius right now. With the few exceptions of those who are truly skilled traders, most of these people simply got exceedingly lucky. The next secular bear market will wipe those folks out, unfortunately.

That’s just how the market works.

The reason secular bears are called “generational” bear markets is because it generally takes about a generation for everyone to forget the lessons of the priorsecular bear. Once that happens, retail investors grow exceedingly complacent. And why wouldn’t they be? Stocks have always recovered relatively quickly from every bear market during THEIR time as investors. Most of them have never studied a very-long-term chart, and don’t realize that not all bear markets are buying opportunities. Even some of those who have studied market history fall into the famous “this time is different” trap.

About a month before the 1929 crash, Yale economist Irving Fisher epitomized the “invincible” bullish sentiment one sees near market peaks, as he rejoiced in the New York Times that:

“Stock prices have reached what looks like a permanently high plateau.”

We have not entered “a new paradigm.” Stocks are not always “great investments for the long haul!” They are great investments during bull markets — but bull markets always, invariably, eventually end.

And when this secular bull finally ends, you do not want to become one of its many casualties.

You need to become smarter than the average broker, even, because the average broker is born and bred to be a perma-bull. It’s part of their training, and many of them simply don’t know any better. Just remember that in the end, they are being trained into the business of getting you to BUY stocks, not convincing you to SELL stocks. The advice they give is virtually always biased (often unconsciously) to the buy side.

My work suggests that the next bear market we experience will probably still be a cyclical bear, so the advice you’re getting to “buy the dip” might work one more time. But I suspect that the bear which FOLLOWS that one (my preliminary time frame is 2025) will be a true secular bear.

But I might not be around to tell you what’s going on then, so the most important thing to remember is that you need to educate yourself.

Written by Jay Hauer on Quora.

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