Double Your Trading Dollars During a Crash

A market crash inevitably brings out the worst in everyone. It even encourages two distinctly poor decisions that can rob investors and traders alike of their money and sanity: doing too much and doing nothing at all.

I often write about overtrading and the negative affects the practice can have on your account balance. While trading too often can be a problem during what are considered normal market conditions, it can be downright dangerous when a manic, post-crash market rears its ugly head. Traders who attempt to prematurely call a bottom could easily get caught in a nasty drop.

When the market moves as fast as it has this week, a protective stop might not even save you.

On the other hand, letting the market crash paralyze your decision making process can also lead to unnecessary losses. It’s all too easy to get stuck watching the drama unfold during a crash. But inaction can cost you if you hang onto positions that you should have liquidated as the markets tumbled below support.

There’s always the temptation to wait it out. It’s usually best to ignore your ego and get out early, instead of waiting for a snap-back rally that may never happen.

The bottom line is that market participants are not acting rationally at the moment. Your best bet in fighting the irrational behavior is preparation…

Two weeks ago, I wrote about the very real possibility that the market could undergo a corrective move. The evidence was in the lagging performance of smaller stocks. The Russell 2000— a closely-watched small-cap index— was falling at an alarming rate, even on days when the S&P 500 or the Nasdaq held strong.

The divergence had been developing for weeks before the actual crash took place. While the Russell rallied alongside the major indexes during the second half of June, it fell way behind in July even before the markets began to panic last week, the Russell was lagging the S&P by more than 2%.

In reaction to poorly performing small-caps, I made the following suggestion: For the more experienced trader, a very short-term position in a weighted ETF, such as Direxion Small Cap Bear 3X Shares (NYSE: TZA) can be a helpful hedge during a market correction.

Since that writing, TZA has risen more than 60%. Looking back, it would have been the perfect trade.

However, it’s easy to look back at the market’s sharp drop this week along with the evidence I’ve presented and assume the move was inevitable. You may have even had the opportunity to sell your short-term trades well before the major downside action took place.

But I’d be lying if I said I saw a drop of this magnitude coming— and I doubt anyone else can honestly claim they were fully prepared for what is now a 12% haircut in the S&P in only five trading days. At least for now, I believe the long and short side are equally dangerous.

Let the market work through this mess— then plan your next move.