Is a recession a Black Friday for stock traders?

If current recession fears are limiting your trading and financial goals, you’re not alone. Given what happened in past recessions, it’s perfectly normal to entertain worries or concerns. But if you have liquidity right now, you might consider taking advantage of a rare trading opportunity that is on the horizon, and having an Exness trading account fully active and funded could be the smartest thing you do this year.

Recessions have come and gone, and while many people and households suffered, there are a fortunate few who took advantage of the previous economic reset. Let’s deep dive into recession trading, explore the signs, and formulate a financial plan for 2023.

How might the next recession affect the stock market?

Every recession temporarily affects the stock market negatively. The 2008/2009 recession had a significant impact on stock prices and the stock market as a whole. The recession was triggered by the collapse of the housing market, which led to a decline in economic activity. Stock prices fell sharply, with the S&P 500 index falling by over 50% from its peak in 2007 to the low of March 2009. The Dow Jones Industrial Average also saw a significant decline, falling by over 50% during the same period.

The stock market stayed low for several years, with the S&P 500 recovering its pre-recession peak in 2013. The Dow Jones Industrial Average took even longer, not reaching its pre-recession peak until 2015.

But in all cases, indices eventually rebound and restart rapid growth. In fact, if you’d been unfortunate to buy S&P the day before the 2008/2009 crash, but held your position, your investment still would have increased by 158% at today’s prices. By the above example, trading indices and certain stocks can clearly offer profitable outcomes during economic uncertainty, even when orders are placed at the worst possible time, but let’s see if we can improve your entry points.

Signs that a recession has begun

Recessions happen on a regular basis, more so in recent decades. If timed right, it's possible to hedge your own inflationary & interest rate losses, and even profit from trading the bearish market, thanks to discounted prices that accompany a downturn. But first, how do we know when the recession has begun? There’s no starter pistol, and the media dare not make such a statement as it could trigger sell-offs across all asset classes, and could even provoke public panic.

“Bad news is an Investor's best friend.” Warren Buffett

For most people, the news of a stock market crash punctuates the beginning of an economic downturn. That hasn’t happened yet, but there are several patterns that precede a stock market crash… and we’re seeing them right now. Big investors are waiting for the known warning signals, ready to pull out and switch to cash, gold, and other haven assets. So what signs appear before a stock crash? Previous recessions were preceded by a significant rise in unemployment, a drop in wages, a loss in consumer confidence, and a decline in currency value–affecting everything from fuel to food prices.

Then there are falling corporate earnings. A trend of declining quarterly earnings reports is a  strong sign that we are reaching the end of the road for this economic phase and moving into the reset. We’ve already seen massive layoffs at Google, Meta, Microsoft, and so many other big-name companies. Four banks collapsed, and companies like Disney, Netflix, and Meta are already reporting losses over the last six months. The dominoes are already falling. What comes next? Layoffs provoke reduced public spending. Companies see less demand across the board and scale back, which leads to a second round of layoffs, more negative earnings reports, and a greater reduction in public spending.

The Bank of America now predicts that within the U.S economy, around 175,000 jobs will be canned monthly, peaking at 500,000 job losses in the coming months.

And so, the economy gets locked into a downward spiral that will eventually correct all the constant growth that every company insists on. It’s a grim picture, but don’t lose hope. Like the mythical phoenix, the global economy needs fire and ash in order to rise again, and buying into the stock market after it’s burned down is one way of getting discount prices before the next rise.

Should you short the market now?

Exness traders can short (sell) stocks and other instruments. Shorting the stock market before a crash could result in a significant earning, but timing that right is like winning the local sweepstake. It’s unlikely, risky, and more like gambling than trading. As of now, all three major indices are down 20% - 30% already, so a short order now would be entering into a bearish action that is well underway.

Since 1946, the average bear market drop was around 30%, the most severe crash being in 2009 when the S&P 500 fell 57%. At the time of writing, we are seeing bearish volatility at about negative 25%, but many analysts and big-name investors are warning that this coming downturn is going to be more virulent than anything economists have ever seen before. Just how low it could go is impossible to forecast. 

It’s possible that yesterday’s short traders may make a killing if the Wall Street analyst’s apocalyptic predictions come true, but that train has already left the station and chasing it now is not advised. Many traders trying to short the market in the coming weeks will find themselves holding low-yield sell orders at prices not much above bottom.

So what should a trader do right now?

First and foremost, your attention should be firmly on the means by which you currently earn money. Whether it’s a job or a business, this is your primary focus. The last thing you’d want to do is open attractive market orders at discount prices, only to have to sell them before the market recovers because of cash liquidity issues. So evaluate yourself and your income and make sure you are in a strong position to ride the coming storm. Next is your spending. Reducing unnecessary spending is also important. While it’s true that anyone following this advice will be throwing fuel on the inflation/interest fire, your liquidity needs to be solid for when the time comes to start trading a market recovery.

For the most part, your money is probably safe in a bank as cash, but in a heavy-hitting paper about monetary tightening, the authors concluded that if just 50% of uninsured depositors decided to withdraw their funds, up to 186 midsize banks worldwide would be at risk of following SVB and Silvergate. Consider diversifying your wealth among trusted entities, just to be sure.

Exness is a massive company with over $3 trillion (USD) in monthly trading volume. In keeping with regulatory agencies including the EU’s CySec and the more stringent FCA of the UK, client funds are segregated from corporate funds and kept in tier-1 banks, giving Exness traders peace of mind. Moreover, Exness has large cash reserves exceeding client funds, ensuring continuous operations, regardless of the economic climate. Just parking your cash in a broker account or under the mattress was once believed to be pointless, but when every other asset is falling in price, sometimes cash can be the safest choice, and when billionaire Ray Dalio admits that cash is no longer trash, it’s worth considering.

Cash has now become such a significant part of the portfolio of huge fund managers that they are holding the highest amount of cash since 2001. Even Citigroup said that cash is the only asset that investors could use as a recessionary lifeboat. Holding onto your wealth but making sure you are ready for opportunity is definitely the order of the day.

Trading after a stock market crash

Stocks and indices suddenly become less expensive. When the markets and media are facing daily doom and gloom, that’s statistically the time to buy. Warren Buffett really had the perfect analogy for this.

“When hamburger prices go down in price we sing, When hamburgers go up in price we weep.” Warren Buffet

But when it comes to the stock market, many traders perceive a bear market as too risky to buy. It’s somewhat like refusing to take that Black Friday 50% discount, believing that it might get cheaper after the sale has ended. It simply doesn’t make sense. Buy low, sell high… that’s the motto of every trader, and stocks don’t get lower than during a recession. Wall street is on sale, and you need to be ready.

Which assets will rebound from recession the best?

So how to know which assets will bounce back the best and fastest? Nobody can answer that with great confidence. But here’s an analogy that might help you target some assets. The market is like a global forest. The largest trees get deeper or broader access to available resources such as light and water. When times are hard, the most established companies have a similar advantage, and they are the ones that bounce back every time.

For example, on average, the S&P 500 fell around negative 29% during recessions, with a 40% rise the following year, rising 58% within two years. This means that buying during the dip is statistically more profitable than pulling out of the market before the low and waiting for the markets to start recovering. It sounds obvious, but we humans are emotional creatures, and there is a hardwired behavior that says, when winter comes, keep your wealth close and safe.

Earlier in the article, we spoke about how, for most people, a stock market crash punctuates the beginning of an economic downturn. But big investors are not like most people. Big investors perceive the stock market crash as the start of spring, not winter. The perfect time to start planting.

A recession trader has to act before anyone else. This doesn’t mean taking your life savings and dumping them on stocks after the first fall. Identifying rock-bottom is not as easy as it sounds. Things look bad right now, but, JP Morgan is forecasting another 20% dip in the market, and that might not be the end of it. Only after the bottom is reached can prices stabilize in the new range. That rage could last weeks, could even last months, hopefully not years. When the markets are stuck, it’s time to get ready.

The bottom line

Patience is key, and not reacting emotionally is paramount. It is possible to simply short the market now before things get worse, but with the Fed wrestling with inflation and interest rates, volatility will likely rise, and unless you have adequate equity to ride those waves, the risks are real and potentially catastrophic.

Whether you decide to short stocks and indices now, or wait for the stock market’s discount sale, your funds will always be secure and instantly accessible with Exness. Exness does offer Stop Protection, which calculates stop-out levels by spread average, not the highs and lows, reducing stop-outs by around 30%. So if you are planning to go for high-risk/high-reward trades, an Exness trading account is a good choice.

If you’d like to get more objective insights on today’s market, click the button below and register your email. Exness registration doesn’t require you to trade, but can still get notifications about breaking news and the latest deep market dives directly on the Exness WebTerminal, and you’ll also be one step closer to trading (when the time is right) with powerful advantages, features, and trading conditions unique to Exness.