What you need to know about stock market crashes
At more than 30% off the top to the recent low, the Shanghai Composite is definitely in crash territory. At the moment, Singapore’s Straits Times Index appears to be spared from contagion but closer, Hong Kong’s Hang Seng Index was down 20% at one point. I put these together for investors.
Awful stock markets
- Both the Straits Times Index and the Hang Seng Index have corrected more than 50% off their top before.
- They did so thrice over the past 20 years.
- The ugliest correction in the HSI was more than 60% after Lehman’s collapse (or subprime mortgage crisis).
- The ugliest correction in the STI was nearly 70% during Asian Financial Crisis.
- Bad luck can come in twos and threes. Just when investors thought the worst of the Tech Bubble was over and safe to come out, they were quickly ‘punished’ by further corrections following 9-11 and SARS outbreak.
- Short sellers beware. Anyone who think they can make money on the downside should take note: while authorities have no problem with irrational, exuberant buyers, they will always villianize sellers. Short selling will certainly be banned.
9-point market crash guide for bulls and bears
- 10% corrections in the stock market are healthy and nothing to worry about.
- 15% corrections might even be labeled ‘oversold’.
- Be very worried if market crosses 20% mark. Bad markets go into a tailspin worsened by margin calls and forced selling.
- Illiquid stocks may gap down repeatedly due to absence of quotes.
- Steep rallies can still happen in the bear market. Do not mistake them for true reversals. Inspect weekly and monthly charts and look out for bullish reversal patterns. Reversal patterns formed over longer duration are more reliable.
- Don’t fall in love with any particular stock. Be quick to cut losses and never average down. Prices come and go, stocks come and go too.
- Price may drop on low volume but price drops on high volume are almost certainly bad. Never catch a falling knife.
- Legitimate ways to make money from a stock crash includes CFDs and exchange traded index futures. Never short sell stocks directly.
- A crisis is a good opportunity. Always have a reserve. Some of the most successful old-timers in the stock market did not trade. They made their money buying generational lows.