By: Katie Gomez

Is a market crash looming on the horizon? With election week approaching, banks showing signs of weakness, and recession fears mounting, savvy traders are bracing for potential market turbulence. Preparation is the key to surviving – and even thriving – during a market crash. Before your hard-earned portfolio value potentially slips away, arm yourself with knowledge. In this article, we’ll explore three battle-tested strategies experienced traders use to shield their investments from sudden market downturns. Whether you’re a seasoned investor or just starting, these practical tips could be the difference between financial distress and resilience in market volatility. 

Look for relative strength

Relative strength refers to assets outperforming the broader market, especially during downturns. These investments hold their value better and may recover quickly when market conditions improve. If you have to buy, look towards relatively strong investments, such as stocks or assets that are solid and sound, backed by evidence of moving averages. Traders are best off finding things that showcase:

52-Week Highs: Assets are reaching new highs while the broader market struggles show significant relative strength.

Moving Averages: Look for stocks trading above their key moving averages (e.g., 50-day, 200-day).

Currently, commodities are stocks that exemplify this relative strength. Commodities have shown relative strength for several reasons, including inflation hedging, supply chain issues, and geopolitical tensions, so they are a safe bet for October. Since inflation is still rising and people are trying to save money, the seller’s market becomes the buyer’s market by focusing on commodities. People are utilizing websites like Amazon storefronts, Offerup, or eBay to sell anything of value to have extra cash on hand. Therefore, the buyers should focus on commodities to cushion their portfolio with tangible value. 

In addition to commodities, traders should also move toward physical forms of currency, such as precious metals (e.g., gold, silver), real estate, and collectibles (art, rare coins, etc.). Find a haven in these commodities because October is already charged with more uncertainty, volatility, and unpredictability than any other month of the year, especially Q4, given that it falls mere weeks before the election.

By steering clear of higher-risk investments such as cryptocurrency or energy stocks, you can avoid adding unnecessary volatility to your portfolio when on the verge of a potential market crash. Keep your investments under close watch, with the ability to liquidate or sell quickly. The easier it is for you to maneuver in and out of the market now is key. Take advantage of this increased demand for essential goods and services and seize opportunities in companies facilitating these transactions by utilizing risk management strategies such as diversification, stopping loss orders, and regular rebalancing.

Going to Cash: The Ultimate Safety Net

If you want to exit the buyer’s market entirely, you would be best off going to cash or selling your positions. While no position means no reward, this is the lowest possible risk option, as nothing is more valuable to have during a market or economic crash than cash on hand.

In extreme market uncertainty, particularly as we approach a potentially volatile October and the final quarter of a presidential election year, going to cash can be a prudent strategy for risk-averse investors.

The “September Effect” often bleeds into October, historically one of the most volatile months for stocks. Coupled with the uncertainty of a presidential election year, the risk of significant market turbulence increases. The final quarter has, in many cases, been a harbinger of market corrections or crashes, especially in election years.

Why Consider Going to Cash:

1. Capital Preservation: Cash is king during market crashes, protecting your wealth from sudden declines.
2. Opportunity Reserve: Cash allows you to capitalize on bargains when the market bottoms out.
3. Peace of Mind: Sitting out market volatility can reduce stress and emotional decision-making.
4. Flexibility: Cash provides the ultimate liquidity, allowing quick pivots in strategy as market conditions evolve.

Implementing a Strategy:

1. Gradual Transition: Consider moving to cash in stages rather than all at once to avoid timing mistakes
2. Asset Allocation: Based on your risk tolerance and market outlook, determine what percentage of your portfolio should be in cash.
3. High-Yield Savings: Look for high-yield savings accounts or short-term Treasury bills to earn some return on your cash.
4. Regular Reassessment: Continuously evaluate market conditions to determine when to redeploy cash into investments.

Potential Drawbacks:

1. Opportunity Cost: You might miss out on market rebounds if you’re fully in cash.
2. Inflation Risk: Over long periods, cash can lose purchasing power due to inflation.
3. Timing Challenges: Deciding when to exit and re-enter the market can be difficult.

For active traders, going to cash doesn’t necessarily mean complete inactivity. Consider splitting the difference by utilizing shorter holding periods for trades, focusing on highly liquid assets for quick exits, Increasing the cash portion of your trading account, and using cash as collateral for options strategies that can profit from volatility. 

Remember, while going to cash offers the lowest risk regarding market exposure, it’s not without its challenges. The key is to align this strategy with your overall financial goals, risk tolerance, and market outlook. Consider consulting with a financial advisor to tailor this approach to your circumstances.

Short Selling: A Double-Edged Sword

Short selling can be a powerful option during market downturns, but it’s not without significant risks, especially when executed close to a potential market crash. This approach requires a high level of experience and careful consideration.

Pros of Short Selling Near a Market Crash:

1. Profit Potential: As stock prices fall, short sellers can profit significantly.
2. Portfolio Hedge: Short positions can act as a hedge against long positions in your portfolio.
3. Opportunity in Overvalued Stocks: Market crashes often expose overvalued companies, creating prime short-selling targets.
4. Market Inefficiency Exploitation: Crashes can create temporary market inefficiencies that skilled short sellers can capitalize on.

Cons of Short Selling Near a Market Crash:

1. High Risk: The potential for unlimited losses if the stock price rises instead of falls.
2. Timing Challenges: Accurately timing the market, especially during volatile periods, is extremely difficult.
3. Short Squeezes: If too many traders short the same stock, a “short squeeze” can occur, driving prices up rapidly.
4. Regulatory Risks: During market crashes, regulators may restrict short selling.
5. Borrowing Costs: As demand for shorting increases, borrowing costs can rise significantly.
6. Emotional Stress: The high-stakes nature of shorting during volatile times can be psychologically taxing.

Executing a Short Selling Strategy: To successfully short sell during volatile market conditions:

1. Conduct thorough research on potential short targets.
2. Set strict stop-loss orders to limit potential losses.
3. Be prepared for rapid market movements and have an exit strategy.
4. Consider using options or other derivatives to limit risk exposure.
5. Stay informed about market news and potential regulatory changes.
6. Seek advice from experienced traders and consider professional guidance.

In conclusion, preparing for a potential market crash requires a multifaceted approach tailored to your individual circumstances. Whether you’re considering moving to cash for safety, exploring short selling for potential profits, or focusing on assets with relative strength, each strategy comes with its own set of risks and rewards. The key is to align your chosen approach with your financial goals, risk tolerance, and market outlook. Remember, no single strategy guarantees protection against losses or ensures profits in volatile conditions. It’s crucial to maintain flexibility, stay informed, and be prepared to adjust your portfolio quickly as market conditions evolve.