How to Prepare for a Stock Market Crash

Shah Gilani

The timing of a possible stock market crash and depression is the bazillion-dollar question right now.

Those are the main topics my readers have asked me about since my Jan. 31 column, "It's Not Time to Sell Everything - Yet."

I'm answering most of them here - and also letting you know exactly what I'm going to do myself.

Here's the start of my plan...

How We're Getting There

Markets last week, especially U.S. markets, got down to "support" levels and dutifully bounced in an orgy of lusting futures and Viagra-fueled excitement.

Higher oil led the charge.

That's worrisome. Oil may not have found a bottom. Falling 60% and then bouncing close to 20%, without any consolidation or a capitulation bottom, isn't a sure sign of anything.

A lot more buyers went "long" (bought) oil looking for a bottom than there were long futures holders selling on the way down.

If oil did put in a bottom and we hold between, say, $45 and $50 (based on the West Texas Intermediate spot price) on the downside, that's good. However, if we break below $43, then break $40, and it looks like $30 is a possibility, all hell will break loose.

All those new buyers loading up on oil, oil stocks, drillers, and explorers will dump their new bets like they were ticking bombs. In the process, all the longs who held on all the way down, because they were in a state of disbelief, will freak and sell, sell, sell.

That would make a crash self-fulfilling.

That could cause a stock market sell-off - a panic. Why? Because investors were very nervous when we got down to support. When oil looked better, they all jumped back in.

All those new players will jump out if the oil's-higher-it-feels-better sentiment turns to an "OMG, we were wrong" psychology. Then, if we get to support again, the same support that just held, and that gets broken, look out below. Margin calls will start rolling in.

Stocks are moving right up to resistance - we're almost there. If stocks can't break out above resistance levels and make new highs but slip this coming week, that's not good.

As far as timing, I'm first and foremost watching oil and how stocks react to oil price movements.

At the same time, I'm watching Europe. European stock markets better bounce, and European sovereign bonds better not weaken.

Interest rates rising, for any reason, will be the canary in the coal mine in Europe. With Europe's new quantitative easing program in place, neither of those two things should happen.

However, if something breaks in Europe, that's another potential market killer. Watch Europe like a hawk.

I'm watching the U.S. dollar. The U.S. Federal Reserve could ratchet up expectations for an interest-rate hike, which would cause the dollar to rise further against all other currencies. At the same time, a lot of other countries are trying to devalue their currencies to make their not-so-robust exports more "competitive."

The problem there is that emerging markets have $5.7 trillion of dollar-denominated debts.

That means they borrowed in dollars and have to convert their home currencies to pay interest and principal in dollars. Their falling currencies against the dollar could trigger defaults. If that happens, the rush out of emerging markets will make 1998 look like a day at the beach. Watch for foreign borrower defaults.

Last, but not least, by a long shot, there's China...

Shah Gilani

About the Author

Browse Shah's articles |

Shah Gilani boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board of Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker.

The work he did laid the foundation for what would later become the VIX - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk, and established that company's "listed" and OTC trading desks.

Shah founded a second hedge fund in 1999, which he ran until 2003.

Shah's vast network of contacts includes the biggest players on Wall Street and in international finance. These contacts give him the real story - when others only get what the investment banks want them to see.

Today, as editor of Hyperdrive Portfolio, Shah presents his legion of subscribers with massive profit opportunities that result from paradigm shifts in the way we work, play, and live.

Shah is a frequent guest on CNBC, Forbes, and MarketWatch, and you can catch him every week on Fox Business's Varney & Co.

… Read full bio