What's Your Exit Plan if there is a Big Crash in the Market?

May 10, 2021

Rahul Shah, Editor, Profit Hunter

It's hard not to feel on top of the world these days if you are an investor. Especially of the small cap kind.

We have analysed price data of around 670 small cap stocks going back one year and guess what we found?

A whopping 96% of them are trading in the positive.

Yes, that's correct.

If you had invested in a portfolio of 15 small cap stocks a year back, you are almost certainly sitting on strong gains in all of them.

The last time this happened was in the year 2017. I remember small caps of all kind going crazy like they have done in the last one year.

However, the 2017 euphoria did not have a very happy ending.

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After touching a high of 20,000 towards the close of the year, the small cap index lost more than 50% over the next couple of years.

And that fall was only in the index.

Individual smallcaps fell much more than that.

In fact, it was common to see smallcaps going down 60%, 70%, and even 80% in some cases, from their 2017 highs.

This was akin to giving up all the gains made in 2017 and ending up at the same spot at which one started.

Worst hit were the investors who entered in late 2017 or early 2018 hoping that the small cap party would go on uninterrupted.

Imagine the kind of wealth destruction they must have suffered over the course of the next couple of years.

To make matters worse, if they would have completely exited the small cap space back in March 2020 after incurring those huge losses, they would have missed the huge rally of the last one year.

Ouch!

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There can't be a worse case of bad timing if you ask me.

It's like you are committing the cardinal sin of entering somewhere near the top and exiting somewhere near the bottom.

Now, let me be clear. I am not saying that we are going to witness the same thing again. In the stock markets, history seldom repeats itself.

However, it does rhyme.

Small-cap stocks may not exactly behave the way they did between 2017 and 2020 but there will be highs and lows for sure.

The index will certainly create a new high and then suffer a big enough crash from there.

What is impossible to predict though, is the exact timing of these events. This is why I strongly believe it's always a good idea to never be 100% invested in stocks all the time.

Since a market crash can come unannounced, one should keep at least 25% of the corpus in fixed deposits or bonds at all times.

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This can go up to as much as 75% if it is getting really difficult to find good quality stocks at attractive prices.

However, it should never go below 25% at any cost.

Right now, for one of my services where I recommend small and micro caps, I have around 50% in fixed deposits and 50% in stocks.

This way, I am prepared for a crash and I'm also prepared for the continuation of this rally.

If markets crash and things start going south, I can deploy the excess cash into stocks and take advantage of their undervaluation.

And if markets keep going up, my stock portion will also go up and add to my overall returns.

I believe this is a great way to reduce risk in the portfolio and at the same time, not take a lot away from the upside potential.

What about you? How are you preparing yourself for some turbulence in the market?

Warm regards,

Rahul Shah
Rahul Shah
Editor and Research Analyst, Profit Hunter

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