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How to trade during a stock-market crash

By Dan Atkinson

08:50, 19 October 2018

Stock markets suffered a mid-October wobble on both sides of the Atlantic, with shares dropping sharply and a sense of panic in the air.

Could this be the start of a dreaded price crash, of the sort that seem more common in the autumn than at any other time of year?

So far, prices seem to have stabilised and even recovered somewhat, although at levels below those seen at the start of October. But that is unlikely to completely sooth the nerves, not least as some unwelcome anniversaries are upon us.

Traders in the best position

The 19 October marks the 31stanniversary of Black Monday, the 1987 price crash that took everyone by surprise and affected every major stock market, other than Tokyo, which was then still closely supervised and even regimented by the country’s powerful Ministry of Finance.

The 29 October will mark 90 years since the most notorious price slide of them all, the Wall Street Crash of 1929 that ushered in the Great Depression.

And we have already passed the 11th anniversary of 11 October which, in 2007, marked the beginning of the US bear market that was to last until 2009. This brings us neatly to the current position, given that 2009 marked the beginning of nine years of price gains on Wall Street, and it is suggested this may now be coming to an end.

What does it all mean for traders? The good news is that it is usually better, in the short term at least, to be a trader during a stock-price crash than to be an investor.

More on that in a moment.

First, how worried ought we to be by recent share-price movements?

Perhaps the most worrying aspect is that they are mirrored in all major stocks markets, suggesting trader and investor sentiment may be on the turn internationally rather than as result of special factors in certain markets.

The correlation among the different indices is striking, and it is worth looking at them in detail. London’s FTSE 100 index stood at 7,510.2798 on 3 October, hit a low for the month of 6,995.9102 on 12 October and is currently about 7,056.59.

In Frankfurt, the DAX fell from 12,287.5801 on 3 October to hit a low of 11,523.8096 on 12 October and is currently about 11,756.72.

False dawns – and dusks

On Wall Street, the blue-chip Dow Jones Index stood at 26,828.3906 on 3 October, dropping to a monthly low to date of 25,052.8301 on 11 October and currently stands at about 25,706.68. The broader Standard & Poor’s 500 index stood at 2,923.4299 on 3 October, hit a monthly low of 2,728.3701 on 12 October and currently stands at about 2,809.21.

Tokyo did not escape this time. The Nikkei 225 fell from 24,110.9609 on 3 October to a low of 22,271.3008 on 15 October and currently stands at about 22,658.16.

This pattern was repeated in markets in AmsterdamParis and Madrid.

XRP/USD

0.59 Price
-3.580% 1D Chg, %
Long position overnight fee -0.0753%
Short position overnight fee 0.0069%
Overnight fee time 22:00 (UTC)
Spread 0.01168

BTC/USD

63,179.55 Price
-5.540% 1D Chg, %
Long position overnight fee -0.0616%
Short position overnight fee 0.0137%
Overnight fee time 22:00 (UTC)
Spread 106.00

US100

17,940.90 Price
-0.180% 1D Chg, %
Long position overnight fee -0.0262%
Short position overnight fee 0.0040%
Overnight fee time 22:00 (UTC)
Spread 1.8

Gold

2,155.02 Price
-0.230% 1D Chg, %
Long position overnight fee -0.0188%
Short position overnight fee 0.0106%
Overnight fee time 22:00 (UTC)
Spread 0.30

How should traders react?

By remembering, first and foremost, that they are traders, not investors. They ought to have no emotional commitment to any particular level of share prices and be as happy to cash in on falling stocks as on rising ones.

So, when prices have dipped substantially, and the trader believes they may fall further down, the trader will go short. This could involve individual stocks, but if the trader is convinced that a generalised price crash is in the offing, they would probably find it more efficient and cost-effective to short one or more indices.

Similarly, signs of a sustainable recovery in prices are the trader’s signal to go long, but a word of warning. False dawns are fairly common during bear markets and there is always a danger of being long when a downward price movement resumes, sometimes quite savagely.

To minimise loss in such a situation, it is vital to keep in mind that a good trader never, in the expression, stays married to their mistakes. Do not assume that your position will come good, or that it “owes” you anything.

Put a stop-loss in place that will automatically bale you out of a losing trade.

The same is true in the other direction, of course, but “false dusks” tend to be less common than false dawns, especially after such a long winning streak on markets.

Alongside “trading the crash” in the stock market or markets, traders will be looking for assets that are either insulated from the effects of the crash or can be expected to benefit from it. Traditionally, gold has been the safe-haven asset to which investors turn when paper securities are falling in value, but its recent mediocre performance despite global political turbulence suggests its price may benefit by less than expected in the event of a crash.

Pointers from history

The dollar may be an attractive alternative, although were the Federal Reserve to cut interest rates to try to stabilise financial markets, that may well cause the US currency to fall on foreign exchanges.

Today, of course, we have cryptocurrencies, such as Bitcoin, whose value is largely unconnected with stock-price movements.

But the best trading strategies cannot answer the fundamental question: are we looking at a stock-market crash? Anyone who could give a definitive answer would, presumably, be too busy making money to share that answer with the rest of us.

However, there are one or two pointers from history that may help.

One is that the 1987 crash was foreshadowed almost exactly 12 months earlier by a period of sudden turbulence on world stock markets. The storm passed as quickly as it had appeared, but the omens were not good.

Two, no-one can agree what caused this month’s period of market turmoil. Was it Donald Trump’s belligerent trade talk or, as President Trump claims, the effect of the Fed’s interest-rate rises? That, too, tends to be a bad sign.

Finally, a good trader never confuses market volatility with risk. Properly handled, volatility can be your friend because it generates trading opportunities. It is risk that you seek to minimise, not volatility.

Oh, and no crash lasts forever. London share prices actually ended 1987 higher than they began it.

Markets in this article

EUR/USD
EUR/USD
1.08428 USD
-0.00303 -0.280%
FR40
France 40
8179.9 USD
28.4 +0.350%
NL25
Netherlands 25
857.59 USD
3.3 +0.390%
SP35
Spain 35
10641.2 USD
29.2 +0.280%

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