Market crashes need to be managed by being prepared for them.

Managing Stockmarket Crashes Ultimately determines your long-term success!

Stockmarket crashes are a fact of life that value investors need to be prepared for. How well you handle a stock market correction (more than a 10% fall) or a crash (more than a 20% fall) will ultimately determine your level of success as an investor over the long term.

The reason for this is that these stock market downturns (a polite phrase for a correction or crash) provide opportunities to purchase stock in wonderful businesses whose stock prices have been swept down in the tide of fear that accompanies these events.

AS A LONG-TERM VALUE INVESTOR, YOU HAVE TO BE PREPARED TO MANAGE STOCK MARKET CRASHES.

WHY? - BECAUSE THEY ARE GOING TO HAPPEN FROM TIME TO TIME!

If the above statement bothers you, but you still want exposure to a stock market, then invest in an index fund instead.

If you think that predicting stockmarket crashes is something that you might get good at - THEN FORGET IT!. Unlike the slow and relatively steady rise in prices that occurs in a bull market, stock market crashes are swift and sudden.

Panic selling is commonly associated with stockmarket crashes. This is characterised by wholesale selling of stock, causing a sharp decline in price. Investors just want to get out of the investment, with little regard for the price at which they sell.

The speed of the market decline may be exacerbated by automated stop losses, pre-arranged sell orders, and the entry of short sellers into the market, selling stock that they don't own and buying it at lower prices to make a profit.

Margin calls on margin loans may cause the downturn to be even worse. The main problem with panic selling is that investors are selling in reaction to pure emotion and fear, rather than evaluating fundamentals. Almost all stockmarket crashes are a result of panic selling.

In the case of individual stock crashes, stock exchanges may place a market halt on some stock in order that the market can better digest the reason for the fall.

Terms associated with stockmarket crashes include a dead-cat bounce which describes a temporary recovery of a market from a decline, after which the market continues to fall.
A falling knife is a term given to a stock whose price or value falls sharply in a short period of time. The term suggests to me that you might get bloodied (lose money) if you try to catch it (buy it) on the way down.

There are several ways I have been able to partially insulate myself from these potentially catastrophic events. I have learnt this from experience as I have gone through several stockmarket crashes in the past ... and they say that experience is the best teacher.

If you can learn from other people's experience then the pain of having to learn the hard way can be minimised.

The first signs of trouble is usually increasing euphoria in the financial press which gradually gives rise to heightened interest by the general public. This can reach the point where everybody wants to buy shares and shares become part of dinner table conversation.

When the taxi driver wants to talk to you about shares, you know that it is time to start selling!

The stock market index provides another rough clue. When the market index approaches historic highs, it is time to be cautious.

The overall price/earnings ratio for the market is another clue. Overall market P/Es commonly vary from a low of about 12 to a high of about 20 with an average of about 15 to 17. Less and less shares appear undervalued as the average market P/E increases.

As the market index and average P/Es rise in a bull market, particular shares in my portfolio start to become overvalued. I compare its P/E ratio to its historical highs and lows for the last few years. If the value gets close to, reaches, or exceeds the average historic high, I commence a staggered sell.

I do this for other companies in my portfolio as the market heats further. As I do this, my margin loan reduces from a maximumm loan valuation ratio (LVR) of 50% and heads down towards 30% - or my bank investment account grows.

Somewhere along the line, a stockmarket crash or downturn occurs. Inevitably, I will still be invested to some extent, but at a lesser level.

But I will have accumulated a cash holding, or will have reduced my margin loan sufficiently to be in a position to start staggered buying back into the market - and quite likely back into the same stock that I sold off previously.

Staggered selling followed by staggered buying is an important strategy for me. Because I can never pick the top of the market - or if I do it is a gigantic fluke! - and a staggered sale allows me to enjoy some more upside if the market continues to rise.

I ACCEPT THAT THE MARKET MAY CONTINUE TO RISE! ... and I view this as part of the exercise ... but being able to sell some more stock helps to ease the pain of thinking that I have exited too soon.

The opposite situation arises for staggered buying after the downturn. If I do a staggered buy when the market looks as if it is getting some life ... and then a dead cat bounce occurs, I have the opportunity to buy more stock at a lower price.

Of course there are two downsides to this strategy that I accept. The first is that I have to pay more brokerage than I needed to, as I am going to be doing extra buying and selling than normal.

The second downside is that the market may fall faster than I anticipated. Depending on the stock, if I am still making a good profit as the market drops to a lower price for the stock, I will sell anyway and not spit chips.

It is common to under-estimate how far prices can fall, so I do not want to be holding over-priced stock that is likely to fall further.

And the opposite case is that the market may rise faster than I anticipated as it recovers from fear and depression.

As the market inevitably overshoots to undervalued levels in these crash situations, losing a small part of the following rise in the price of some stocks that I buy into is something that I am happy to accept.

In this discussion, I should not forget retirees (like me) who are enjoying income from superannuation funds. They are also in a position to ride out stockmarket crashes in a sensible manner.

As we are all living longer, it is important that our superannuation has exposure to the share market since it offers the best returnss over the long term.

As most of us will live for some 20 to 25 years after retirement, superannuation is, from the beginning of retirement, still a long-term investment. So it should be exposed to the best returning asset class ... namely shares, in order to make it last by allowing for growth over time.

But retirees, unlike most other people, need to withdraw funds regularly to cover living expenses and other purchases.

The strategy I use is to insulate three year's living expenses, together with any major purchases I am planning to make in that time, in cash and put the remainder in equities, local and international.

This means that the assets can better ride out stockmarket crashes by having living expenses withdrawn from the less volatile cash component rather than having to sell more volatile shares, the price of which are depressed during a market crash.

In summary, my experience tells me that to be a successful long-term value investor, market crashes need to be managed by being prepared for them.

It is these inevitable events that give rise to the best opportunities to buy the best businesses at prices below their intrinsic value ... and that is what value investing is all about!

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