5 Ways to Deal With A Big Market Crash

Dear Rich Lifer,

Markets are clearly on edge about the coronavirus, and quite frankly, there’s no way to be sure how much fear about is actually justified at this point in time.

For me, the bigger issue remains insanely high valuations for a number of momentum stocks… prices that simply aren’t justified by business fundamentals.

Maybe you’re worried about one, the other, both, or something else entirely.

At the very least, maybe the big drop on Monday was a reminder that volatility can come back into the picture at any time and that market drops and crashes are almost certain to happen again in the future.

Well, I also have good news: There are at least five different ways to deal with inevitable periods of decline, whether big or small.

The first two are really conservative moves:

Choice 1: Do Nothing

This is a great approach for your core income positions and/or any long-term investment that you really believe in. Just note that by “long-term,” I’m talking years not months.

Choice 2: Move to the Sidelines

If you have big profits that you want to protect, this can make sense. Especially if you’re not really married to the investment philosophically.

However, if you’re cashing in your chips simply as an emotional response, you’re almost definitely NOT making the right choice.

Meanwhile, you can also consider actively hedging your portfolio or going for PROFITS when various assets decline in value.

The oldest way to do that is …

Choice 3: Consider Short Selling

“Shorting” is the process of borrowing an investment and hoping you’ll be able to buy it back at a lower price in the future.

And while the idea gets a bad rap, it can actually be a great approach if you’re very sophisticated and watch your portfolio like a hawk.

The problem is that, for most regular investors, it simply involves too much risk and complication.

For starters, you have to use a margin account — which requires special clearances.

 In addition, the very use of margin can potentially expose you to big risks, including the possibility of having to sell other investments to cover losses… or even the chance of losses piling up beyond the total value of your entire nest egg.

It can be a very risky strategy, so I wouldn’t recommend it to anyone who isn’t a seasoned investor.  

So there are now two easier ways for most people to profit from market dips…

One of them is …

Choice 4: Use Put Options

The availability of options now allows you to get many of the same benefits of short selling without the unlimited risk.

So rather than shorting a stock or other investment, you can simply buy a put option on it. 

Right upfront, the potential loss for getting the trade wrong is limited to the amount of money you spent on that put contract (as well as any commissions).

Meanwhile, if you’re right… and the stock drops before your put contract expires… you can reap a very substantial gain in a relatively short period of time.

Of course, options are still relatively advanced tools. Plus, like shorting, they require special clearances from your broker.

You also can’t speculate with options in regular retirement accounts like IRAs, either. (You CAN sell options to generate extra income, but that’s a different thing.)

Which brings me to my favorite way to hedge or profit from declines …

Choice 5: Use Inverse Exchange-Traded Funds (ETFs)

You probably already know the basics about ETFS, including some of the advantages they bring to the table.

Well, inverse ETFs carry all those same advantages while allowing you to profit whenever a particular market or group of investments goes DOWN.

Let me give you a real-world example of how I’ve personally helped readers use them in the past: 

It was the summer of 2008, and I already sensed that the burgeoning financial crisis could send the stock market plunging.

At the same time, I didn’t want to tell my readers to give up their steady dividend payments or abandon their core stock holdings.

 Instead, on August 8th, I told them to consider hedging their portfolios with a simple inverse ETF that would rise in value if the Dow index dropped. (First red line in my chart.)

Sure enough, the market DID start cracking as you can see from this chart of the broad market.

So on September 30th, I recommended they double their stake in the same inverse Dow ETF. (Second red line in my chart.)

Again, that proved to be a good call… because shortly afterward, the market REALLY caved… dropping as much as 36% in just the next two months.

And so what happened to the value of that inverse ETF? 

It took off!

In fact, because it was the ProShares UltraShort Dow 30 ETF (ticker symbol: DXD) — which is designed to surge TWICE AS MUCH as the Dow falls — it actually rocketed in value more than 70%!

Anyway, once it looked like things were starting to settle down a bit by the end of the year, I recommended readers close out their entire stake in the ETF (green line in my chart).

Total tracked profits?

My records show readers could have earned as much as 65.4% on the initial recommendation and another 43.7% on the follow-on recommendation.

Those are huge double-digit wins while most regular stock portfolios were getting crushed.

And you don’t need to wait for a once-in-a-decade move, either. You can use inverse ETFs to play a $50 drop in gold … a 4% decline in stocks … or any number of other regularly-occurring market dips.

As a current example: The DXD jumped 6.97% on Monday, a very nice move for a single day.

There is just one other thing you need to know about inverse and leveraged ETFs:

You should only use them for very short time periods because of something known as tracking error. 

In simple terms, the idea is that these funds are constantly resetting themselves to a baseline so the effect of compounding can skew their longer-term movements. 

But here’s the takeaway: No matter which direction markets are heading, you have plenty of ways to make money – whether it’s continuing to collect dividend checks or using more sophisticated investments to make short-term profits from the declines themselves.

To a richer life,

Nilus Mattive

Nilus Mattive

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Nilus Mattive

Nilus is the editor for the daily e-letter The Rich Life Roadmap and a Paradigm Press analyst.

Nilus began his professional career at Jono Steinberg’s Individual Investor Group, where he published his original research through a regular investment column. Later, he worked for a private equity business and spent five years editing Standard and Poor’s...

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