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How to react to a stock market tanking – what not to do

As the US stock markets reached new highs in the first quarter of 2021 in the wake of coronavirus recovery positivity, many shrewd observers were warning of artificially inflated valuations.

That proved to be a correct observation, and in difficult conditions for business – plus surging inflation – the stock market has not crashed, as such, but has certainly experienced what is colloquially known as ‘tanking.’

The data can be confusing – inflation is generally considered a negative economic trait, which devalues cold, hard cash and thus pushes people into investing in other assets. However, there is the fear that earnings will suffer as a result, and so expectations are dampened – increasing selling pressure.

So, in these (cliché alert) unprecedented times, retail investors felt the fear and pulled the plug on their positions – the Nasdaq fell from $165.37 on Monday May 10 to $157.30 by Wednesday lunchtime, which is significant by anybody’s measure.

The market had rallied again by the end of the week, but it just shows how predicting a possible ‘tanking’ – and knowing how to react to volatility – is essential for traders seeking to protect their investments.

So how can you overcome a market tanking?

Step 1 – Invest wisely in the first place

If you are fully confident in the long-term prognosis of your stock or forex investments, then a short-term downturn is of less consequence, isn’t it?

The key to avoiding the psychological stresses of a market tanking is to ensure that you have complete faith in your assets, that you have researched them fully and that you are in it for long-term gains, rather than a short-term hit – being locked into open positions in ‘hype’ or fad assets is only going to end in disaster during a tank.

Never chase a quick buck in investing – those burned by a downturn learn that lesson the hard way.

Step 2 – Don’t panic!

What do we do when there’s an emergency? We panic.

That’s our natural defense mechanism, but after the momentary raising of the heart rate, the key is to find a sense of perspective…and fast. That mindset is the same whether you have set fire to your dinner or whether the stock market is in freefall. 

The most successful traders embrace a downturn, visualize what it will mean to their holdings and prepare for it. Risk tolerance is a term that is widely used in investing, but it is certainly something that we should all be embracing.

How much are you prepared to lose of your bankroll? How long are you willing to wait for a reversal? These preparatory questions will ensure you don’t panic when the market does bomb.

Step 3 – Take emotion out of it

If you are concerned about how you might react in the case of a market downturn, then maybe it’s smart to take the emotion out of it.

Robo advisers and managed accounts are one way that you can hand the reigns over to either an experienced investor or an algorithm-based software package that, obviously, does not suffer from the same fallibilities as us mere humans.

There are many different robo-advisers out there, and these often let you choose your own investment strategy – from the conservative to the more aggressive. These can be modified too, so if you are concerned about how emotional you might be when greens turn to red, this might be the avenue for you. The good news is that the Wealthify fees and those charged by other brands are not as prohibitive as you might think.

Step 4 – Diversify & stop-loss

One of the best ways to combat a market tank is to ensure you’re not too heavily invested in a single asset.

Consider diversifying your portfolio into a variety of instruments and markets and consider the relationship between the various assets and how they perform in a tanking environment.

Gold and some other precious metals, for example, are considered ‘safe havens’ that hold their value even in a downturn. Some forex options, such as the Swiss Franc, are also considered to be safe plays. 

Another tactic you can deploy in a downturn is the use of a stop-loss. This is a strategy that is on the first page of the trading textbook, and yet there are still those bullish investors who don’t think they have to worry about such ‘negative’ things – big mistake.

By deploying a stop-loss in your trades, you can hedge your bets and minimize the impact of a market downturn – it’s all automated too, so you don’t have to panic about closing positions when you’re supposed to be otherwise engaged!

In conclusion, as you can see there are tools you can deploy that will protect your investments when the market tanks. So, keep calm and carry-on trading.

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