You want to survive this crash and the next one? Then follow Downtown Josh Brown’s Rules for Surviving a Crash:

1. Acknowledge that its a crash. Once we’re past down 10% in the Dow Jones Industrial Average from wherever the peak was (yes, the Dow is a way better crash gauge than the S&P 500), you can stop saying correction and start saying crash. Better to be wrong in hindsight on the nomenclature.

2. Pencils Down! Whatever trendlines or individual stock research you were working on needs to be shelved for the moment. Your drawings and calculations will not work here. If you happen to buy a stock and it rips higher, it will not be because of your research, it will be because the market went up. Correlations always get jiggy in crashes, stocks become commoditized like bushels of wheat that must be liquidated regardless of the underlying businesses.

3. Don’t listen to “stockpickers” or sell-side equity analysts. They are only looking out from within their own little bubble and they cannot comprehend the other little bubbles around them let alone the whole bathtub. Anyone covering specific stocks needs to know when the macro gyrations trump whatever earnings they’ve estimated or the conference calls they’ve listened to. There’ll be a time to “know your stocks” but this ain’t it.

4. Ignore the asset-gatherers and the brokerage firm strategists, their job is to calm markets and soothe investors. Let’s say Morgan Stanley runs $1 trillion in stock market wealth for investors. And then let’s say they felt there was serious trouble ahead. Do you really think they would ever make the sell call? Can Morgan Stanley really say “Sell 20% of your equities”? No. Because that would be $200 billion in supply hitting the stock market at once – they would crash it all by themselves! Too Big To Keep It Real has always been the problem with the wirehouse advice model.

5. Make sacrifices by reducing stock exposure by beta and volatility. This is my iron-clad rule. The moment you recognize the crash, kick the small caps, biotechs, emerging markets etc. You must separate your feelings for a particular asset class, sector or individual stock and recognize that the higher the volatility, the worse they’re gonna act in the short-term. I have a prenuptial agreement with every position I put on and we get divorced cleanly in a crash situation if need be.

5a. Also, margin balances must get cleaned up immediately, take the losses, I don’t care. Because broker-dealers and clearing firms can and will raise equity requirements right at the moment of maximum pain and force you to sell out later – and lower. I could tell you war stories you would not believe, kids.

6. Make two lists. The first list everyone knows about and talks about – the “if they get cheap enough I’ll buy it at that price” shopping list. Fine, but don’t forget the “things I will sell on the next bounce list”. Even the worst markets have short-term bounces in the midst of the chaos, use these bounces to get rid of the things that make you ill on the red days, even if you’re taking a loss. The stocks you bought on a flyer one day or the companies that have been disappointing or where the story has changed – sell ‘em on the rips.

7. Watch sentiment more closely than technicals or fundamentals. Pay attention to the squishier things in a crash moreso than you would normally. Are people screaming in pain? Or are they still looking for a bottom? Or have they given up entirely? There is no math to this, a lot of it is “feel”.

8. Abandon any hope or intention of catching the bottom. You won’t and it is unnecessary. No one will carry you out on their shoulders if you manage to do it but you will definitely get carried out on a stretcher if you get it really wrong with your own capital. Keep in mind that time becomes more important than price…not where will it end but when?

9. Suspend disbelief. “Bank of America could NEVER be a $5 stock!” “How could Bear Stearns possibly go out of business, its a hundred-year-old firm!” “No way this stock should trade at 5 times earnings, it’s a Dow component!” “How could the market go down 5% four days in a row?” Guys, anything can happen in a crash, there are machines making the trades and they have no respect for the prestige or standing of a particular company. This is both gut-wrenching to behold and great for the level-headed who eventually got to buy Wells Fargo in the teens or Apple in the $100s once the bottom was in.

10. Stop being a know-it-all and shut up. If you are telling people a price or a support line where the selling will end, you are only kidding yourself. Have a guess based on your discipline and research, but don’t act like you’re talking facts. Fair Value is fine, but call it a guideline. Support is also fine, but call it a historical estimate of where buyers have come in before. The deal with crashes is that extremes are the norm, not the exception. Things tend to overshoot through reversion to the mean trendlines or fair value estimates on their way back to stasis.

Downtown’s Rules for Surviving a Crash,
The Reformed Broker, August 19, 2011

Category: Economy, Markets, Psychology

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

12 Responses to “Rules for Surviving a Crash”

  1. dougc says:

    Agree totally.

    11. If you must gamble and a casino isn’t available, short an index.

  2. BusSchDean says:

    Any hope of getting the finance gurus working on the federal compromise to consider #10 & #5?

  3. ga082003 says:

    Is apple a short or a long?
    Fundamental wisdom says Short

  4. theexpertisin says:

    #10 is a Golden Rule for life, not just for surviving a crash.

    My New York area friends might disagree!

  5. number2son says:

    Breaking news… Jobless claims rise

    Yay! More selling …. sigh

  6. VennData says:

    1. The S&P is a better gauge of the the market, a crash, anything …than the DOW. VTI is a better gauge than the S&P.

    2-10 are nonsense. Simply re-balance your portfolio. Say you have 20% in the Total US stock market (VTI,) 20% in foreign (VXUS,) 20% in small-cap value (VBR,) 40% in TIPs (IPE.) Your TIPs are up, the other three are down, so sell TIPs and buy the indexes of the other 3 asset classes.

    If you have any other sort of portfolio you are a speculator, not an investor,

    Use index funds/ETFs to set up a portfolio of three-five or six asset classes, rebalance when your original asset classes allocations are out of whack. it’s simple, easy and you have the best chance to get your share of equity gains with your savings. Over the long run you will probably outperform anyone trying to time the market with individual stocks, aka speculators.

  7. cjcpa says:

    Now we are certainly going to get QE3, so markets will rise!!!
    (that is only partially sarcastic as bad is the new good.)

    (just typed a reply several posts back)

    back to the salt mine.

  8. ToNYC says:

    10. Stop being a know-it-all and shut up.

    Trading rule #10
    could be re-ordered as 1,2, and 3
    Real Estate valuation rule 1,2, and 3
    being “Location”

  9. Smokefoot says:

    Why is the DJIA better than the SP500 for measuring crashes?

    Venndata: simply owning individual stocks is not enough to make a person a speculator. There is nothing in the definition of investor which implies ETFs. Someone following Ben Graham is also an investor, just someone who need to put in more work to do it.

  10. AHodge says:

    all good except maybe #8
    abandon all hope ….catching the bottom”
    you are after all recommending some timing
    the “when rather than “where is good..
    but you have to sell a top somewhere and get back in somewhere?
    the good news is you do not have to be that good.
    if you are aiming to be in 80% of the time
    sell only when really nervous buy back in somewhere lower dont be premature
    if you only catch half the selling or get back in after some recovery starts
    you will come out way ahead

  11. bear_in_mind says:

    If only we’d had these tips in the Spring of 2000!!!!