A market crashes when it falls more than 10% over a short period of time. This may be due to natural corrections when bull runs extend irrationally to unsustainable levels. It may also be due to sudden, unexpected occurrences like the 2008 global sell off. In both cases, stock market crashes fueled by frightened investors could lead to bear markets or even recessions.
How to lessen the impact:
Diversify your portfolio (preempting)
Maintaining a diversified portfolio of stocks, bonds and commodities would allow you to lessen the impact of market crashes, as these assets usually react differently to market conditions.
Don’t panic sell (pulling through)
Don’t give in to the temptation to sell. Stock market crashes tend to make individual investors sell at very low prices. It’s important to remember that markets usually make up for the losses in the months following the crash.
When markets go up again, panic-driven sellers are usually too afraid to buy again initially. So they probably do not buy in time to make up for their losses.
On the other hand, long terms investors with diversified portfolios should not be impacted as their strategy is not to profit in the short term, but rather in the long term. So for them, this is a natural dip which they will see through, as long as they still believe that the long term prospects of their stocks are still good.
Hedge and rebalance (reacting)
Hedge by buying into safe haven assets, like gold, early on. During the early days of crashes, frightened investors panic, sell their stocks and buy gold. Governed by the rules of supply and demand, gold prices increase dramatically as a response. They usually start to fall again towards the end of the crash – signalling a good time to sell.
Another reaction is to rebalance your portfolio by buying into new industries and/or heavily impacted ones.
Contrary to market dynamics and depending on the cause, some industries/companies might benefit from a market crash – think of pharmaceutical companies tasked with developing vaccines and cures to the Coronavirus pandemic. Such companies might be expected to profit from the situation which will have a positive impact on their shares.
On the flip side, heavily impacted companies might mean that their share prices are now relatively cheap and will likely rebound to previous highs. This signals a great opportunity for investors to recoup their losses by over indexing on these companies.