How to Play a Market Crisis

The current liquidity/credit crisis is the first market crisis I’ve experienced since I started investing not too long ago. Prior to this, I was always hoping for a crisis, coz if you look at the historical charts, crisis times are simply the best times to make tons of money =) Those are the times where you have Amazon going from $6 to $60 in 1 year, etc.

Well, after the happenings of the past few weeks, I’m proud to come to the realization that I was not fully prepared to take full advantage of this crisis. You can tell from a couple of my earlier posts of the mistakes I’ve made and some learning points. I’m still making mistakes and still learning, and hopefully by the end of this episode, be fully prepared for the next one (which sadly should be many years away). Its a pity though that I had not come across any materials before on how to play a market crisis.

What I would like to do in this post is to simply list down my learning points on how to play a market crisis. I’ll keep updating this post as I learn more pertaining to this topic.

Well, here goes:

  1. You’ll typically hear of an impending crisis way ahead of time from the mass media (e.g. dot-com crash, housing market crash, China market crash, etc.)
  2. Foretelling the impending drop of the two types of crashes:
    1. Fundamental event-driven: e.g. housing market.
    2. Non-event-driven: e.g. dot-com overvaluation crash
      • This one is harder because the crash could happen at any time, like the Cinderella analogy that Buffett used.
      • Jim Cramer offers some tips (see Spotting Tops here).
      • Charles Biderman’s thinking on looking at margin debt, mutual fund flows, change in net trading float may be useful. See here.
      • Bill Miller said that “The NYSE financial index is probably the best barometer of what’s to come. The financials tend to be a very good indicator of where the market’s going. They tend to lead the market because they’re the lubrication for the economy…… But just as financials lead on the downside, they will lead on the upside.”. The symbol is ^NYK on Yahoo Finance (or here). Jim Cramer uses the KBW Bank Index (symbol ^BKX) as a leading indicator.
  3. Identify the good companies that you think will survive and prosper after the crash. These will be the companies that will be thrown out together with the bathwater and where you would make your money. The earnings conference calls that you listen to in the earlier step would be a great chance to identify the good/bad companies.
  4. Once you judge that the crash is impending, sell out all your positions (if you’re a small investor). Read more here.
  5. If you’re adventurous, you may want to short the lousy companies, esp. those that would likely end up in bankruptcy.
  6. Wait until the crash happens. If you’re adventurous, you may want to
    1. Wait for a one-day big drop in all affected companies (e.g. mortgage, dot-com)
    2. For severely whacked companies that are good companies (e.g. babies thrown out with the bathwater), buy in at the end of the big-drop day (or start of the next day) to ride a bounce back
    3. Sell off immediately after the bounce back (or at most 1-2 days later), wait for it to drop further, the pain is not over yet
  7. Wait and wait until maximum pain. Cramer gives some excellent advice on spotting bottoms here.
  8. Once you judge bottom has been reached, slowly buy in good companies bit by bit at good prices.
  9. If the price is still going down, you may want to do this (read Getting in during/after the drop).
  10. If the price is still going down, you can buy in more if you have the capital. If not, endure the pain =). Do not start selling off hoping to avoid some short-term loss, unless you are extremely extremely sure there will be another significant drop, which should not be the case since you had earlier made the determination that the bottom has been reached.
  11. Wait for the gains 🙂


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