Anyone who lived through the stock market crash in October 1987 will never forget how a sudden drop creates a market panic. Everyone tries to sell. Logically, then, shouldn't short sellers be in the best position to reap huge benefits? Only if the markets can handle the volume. Since we here at Elliott Wave International forecast a major downturn, we have also given thought to how investors should handle their investments. Bob Prechter has written a whole book on the subject, called Conquer the Crash, which came out in a second edition the end of 2009. For his considered advice on whether or not to speculate in stocks during a deflationary crash, please read this excerpt from the book.
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Should You Speculate in Stocks?
Perhaps the number one precaution to take at the start of a deflationary crash is to make sure that your investment capital is not invested “long” in stocks, stock mutual funds, stock index futures, stock options or any other equity-based investment or speculation. That advice alone should be worth the time you spent to read this book….
Short Selling Stocks and Trading in Futures and Options
Short selling is a great idea at the onset of a deflationary depression, at least from a timing standpoint. Shares of vulnerable banks and other financial companies in particular are a great downside bet….
Unfortunately, there could well be structural risks in dealing with stocks and associated derivatives during a major retrenchment. Trading stocks, options and futures could be extremely problematic during a stock market panic. Trading systems tend to break down when volume surges and the system’s operators become emotional. When the exchange floor became a hurricane of paper in 1929, it would sometimes take days to sort out who had bought and sold what and then determine whether investors and traders could afford to pay for their positions. You can experience the turmoil vicariously in any good history of the 1929 crash. To give you a flavor of what goes on, read this description, from one of my subscribers, of the tumult during a comparatively mild panic [50] years ago:
"I worked for Merrill Lynch in New York in 1962 during the collapse. I well recall the failure of the teletype in our office and inexperienced clerks calling in the orders to the main office. I recall many of the screw-ups: buys called in as sells and vice versa. Some stocks had nicknames like Bessie (Bethlehem Steel), Peggy (Public Service Electric and Gas), and I recall the clerks calling in the orders by the stocks’ nicknames and the person on the other end not knowing what the hell they were talking about. All the while, the market was collapsing."
Do you think investors and brokers will behave differently now that so much stock trading is done on-line? I don’t. Do you think the experience will be “smoother” because modern computers are involved? I don’t. In fact, today’s system — much improved, to be sure — is nevertheless a recipe for an even
So Where Should You Put Your Money Now to Preserve Capital? You can learn exactly where in Bob Prechter's most recent
Elliott Wave Theorist. He lays out 10 assets to hold as well as 13 to avoid. Read more about it
here.
bigger mess during a panic. Investors will be so nervous that they will screw up their orders. Huge volume will clog website servers, disrupting orders entered on-line. Orders may go in, but confirmations may not come out. A trader might not know if his sale or purchase went through. Is he in or out? Quote systems will falter at just the wrong time. Phone lines from you to the broker and from the broker to the floor will be jammed, and some will go down. Computer technicians will be working overtime while being distracted worrying about their own investments. Brokers will be operating on little sleep and at peak agitation, since most brokers are themselves bullish speculators. They will enter orders incorrectly. Firms will begin to enact and enforce tighter restrictions on trading and margin. Price gaps will trigger stops at prices beyond the ability of some account holders to pay.
You, the wise short seller, could survive all these problems only to discover that your broker has gone bankrupt or has been shut down by the SEC or that its associated bank has had a computer breakdown or that its assets are depleted or frozen.
Unless you are prepared for such an environment, don’t get suckered into this maelstrom thinking that the bear market will be business as usual, just in the other direction. If you want to try making a killing being short in the collapse, make sure that you are not overexposed. Make sure that if the system locks up for days or weeks, you will not be in a panic yourself. Make sure that in a worst-case scenario, the funds you place at risk are funds you could lose.
So Where Should You Put Your Money Now to Preserve Capital? You can learn exactly where in Bob Prechter's most recent Elliott Wave Theorist. He lays out 10 assets to hold as well as 13 to avoid. Read more about it here.