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After hours earning call is the perfect time for a stock price to go up or down significantly, as well as in a few minutes after the market open. The example of LinkedIn stock crashing is an example. As an individual investor, you will be late and by the time you are ready, the price has already crashed. The bad news reaches you after a few minutes later even if you are alert 24/7.

How do you protect your investment in such situations?

wonderful world
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    By placing a guaranteed stop-loss order when you first buy your stocks. Check if your broker provides them, and if they don't search for one that does! – Victor Dec 07 '19 at 05:48
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    Do you mean stop market and limit which is mentioned in the article https://www.investopedia.com/articles/active-trading/091813/which-order-use-stoploss-or-stoplimit-orders.asp ? The article says it is NOT GUARANTEED. – wonderful world Dec 08 '19 at 00:34
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    @wonderfulworld No. If he meant that he would have said that. What he said was a guaranteed stop-loss order (GSLO). – David Schwartz Dec 08 '19 at 01:10
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    Simple: Stay out of the stock market. – Hot Licks Dec 08 '19 at 02:50
  • Read Michael Lewis' Flashboys and realize that you are holding the short end of the stick. – Peter - Reinstate Monica Dec 08 '19 at 21:21
  • What does Flashboys have to do with this? – Bob Baerker Dec 09 '19 at 14:11
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    FYI any technique for protecting against an unwanted event is called a hedge; that is where we get the expression "hedge your bets". You might use that keyword to research different techniques. But the fact that you are asking the question indicates that risky investments might not be right for you. – Eric Lippert Dec 09 '19 at 17:24
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    @Victor I'm curious how the broker hedges these... do they buy puts? –  Dec 10 '19 at 00:27
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    @Michael - firstly, they charge you a premium for placing the GSLO. Regarding hedging the GSLO, that might depend on the liquidity and stability of the instrument being traded! – Victor Dec 10 '19 at 00:38
  • @EricLippert I made some investments in one stock a few years ago and the value was going higher, but then it dropped in a few minutes after the earnings call. I did not know how to do the stop loss at that time. I also did not know Put that this question is talking about. So hedging strategy is important as you said. – wonderful world Dec 11 '19 at 11:28
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    @wonderfulworld: No, that is not the lesson to learn here. The lesson to learn is do not invest in single stocks if you are averse to risk. Instead choose an investment strategy that has lower volatility, like an index fund. – Eric Lippert Dec 11 '19 at 16:12

6 Answers6

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By buying put options for the stock.

A put option gives you a time-limited right to sell a stock for a specific price. Even if the actual price of the stock is below that price at the moment. This can be used as an insurance against an unexpected price drop, because it puts a maximum on how much money you can lose. But:

  • The put options cost you money, no matter if you use them or not. If the stock stays above the strike price, you spent money on an option for nothing.
  • The put options can only be used until a specific date. If you still hold the stock after the date expired, the options are useless and you need to buy new ones. Depending on how the stock has developed in the mean-time, the price for the put-options might also have changed.
  • Keep in mind that option trading is one of the more advanced techniques in stock trading. When you think that buying a stock would be too risky to buy without insuring it through a put option, then maybe you shouldn't invest in that stock at all. If you consider yourself a risk-averse investor, then it might be smarter to stay away from stocks of individual companies. Diversify by buying funds instead.
Philipp
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    Good explanation. I'd add that buying a stock and buying a protective put simultaneously is equivalent to buying a call. – Bob Baerker Dec 07 '19 at 15:29
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    but don't do it right before earnings, as everyone else has already done so and it will cause greater losses (in the put option) after earnings. – CQM Dec 08 '19 at 03:08
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    @CQM - Around earnings is a good time to sell premium. If one wants to hedge near earnings when IV is inflated, it's a good idea to lay off some of that overpriced time premium paid out by selling some overpriced premium as well. A vertical works but the best low/no cost hedge would be a collar. – Bob Baerker Dec 08 '19 at 03:51
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    Worth also saying that even though you can make a fortune buying and selling options, they also carry huge risks – Luffydude Dec 09 '19 at 15:01
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    @Luffydude Can you elaborate on how and why options trading is risky? – Philipp Dec 09 '19 at 18:21
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    @Philipp - the are a number of ways to use options conservatively but true directional option trading is very risky unless one has an edge and few who trade options actually have that. Risk and reward go hand in hand. If you chase the big bucks, you have to risk the big bucks. – Bob Baerker Dec 09 '19 at 18:35
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    @BobBaerker Doesn't a call cost a lot less than a stock plus a put? – Monty Harder Dec 09 '19 at 23:28
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    @Monty Harder - Yes, a call costs a lot less than the combination of stock plus a put and for that reason, one should usually do the natural trade rather than the synthetic, whenever stock is involved, assuming that the combo is being done simultaneously. Legging in is a different story (buy stock now, buy put later after stock appreciation). Another example is a covered call which is equal to a short put. If considering doing the CC today, sell the cash secured put instead. Fewer commissions (if still paying them), one less B/A spread, and easier to exit, if need be. – Bob Baerker Dec 09 '19 at 23:47
  • @Philipp take one look at wallstreetbets and look for loss posts – Luffydude Dec 10 '19 at 10:11
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    @Luffydude No, please you do that and tell us what kind of option trades should be avoided and what kind of option deals are save. Yes, there are a couple things you can do with options which are extremely risky (like short-selling them, for example), but the strategy I explained in this post is a use of options which mitigates risk by using them in the way they were intended. Please don't spread FUD by saying "options carry a huge risk" when the situation is a lot more complex and nuanced than that. That way you are just spreading misinformation and are doing your readers a disservice. – Philipp Dec 10 '19 at 10:15
  • @Philipp I'm at work now but I agree with you in that spreading FUD is bad. It's just that people need to do proper research before buying/selling puts/calls otherwise they might end up huge numbers in the red. There are(were?) a few ways in robinhood you could mitigate this with infinite leverage but they might get patched soon – Luffydude Dec 10 '19 at 11:30
  • The comments is no place for an exhaustive list of options strategies and their risk profiles. wow. – CQM Dec 11 '19 at 17:39
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How to protect your investment in such situations?

By diversifying.

If a company whose stock you own goes bankrupt, and it's a problem for you, your stock portfolio is not diversified well enough.

In fact, I would argue you should be prepared for as many as 2-3 companies whose stocks you own going bankrupt.

By understanding into what you invest.

If you invest in a company that has been the market leader for 30 years, chances are it doesn't drop much in value, assuming the valuation at which you purchased the stock seemed reasonable.

The largest investments in a well-diversified portfolio should be just like that: major companies with large market cap. Your investment into them is unlikely to vanish.

By buying more.

If you diversify well, and invest into good companies at a reasonable valuation, and suddenly all of your investments have dropped 50% or so because the market index has dropped, it's a very good chance to move more money from bonds to stocks. It's also a very good chance to reduce your spending so that you have more money for investing.

juhist
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    Diversification does not protect you. It just spreads the risk. In 2008, of the 11 sector SPDRs, the top 3 performing sectors were Utilities (-43%), Health (-37%) and Staples (-31%). That's hardly saving yourself. Understanding what you invest in would not have helped you back then either (market down 50% during the GFC). Buying more does not protect you either. It may be a wise investment decision but it does not "save ourselves from large drops in stock price" and it increases your exposure to greater losses. – Bob Baerker Dec 07 '19 at 14:20
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    @BobBaerker how quickly did those sectors rebound, compared to the S&P 500? (Shallower drops and faster rebounds is a form of protection for long-term investors staring at retirement.) – RonJohn Dec 07 '19 at 15:39
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    @RonJohn - The question was, "How to save ourselves from large drops in stock price?" Suggesting that a subsequent rebound after a deep correction is a form of protection is a bit convoluted. As for those facing retirement, their strategy should be geared to more fixed income and less risk so that their retirement is not compromised. As for how quickly those sectors rebounded compared to the S&P 500, you know what you have to do if you want that answer... – Bob Baerker Dec 07 '19 at 15:57
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    @Bob Baerker: And if you'd held on to a diversified portfolio of those sectors for a few years (about 5 years for the DJIA), they'd be back to where they were before the drop. Which leads to another strategy: invest for the long term. – jamesqf Dec 08 '19 at 01:13
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    @jamesqf - It's a Captain Obvious statement to say that if you have a losing position and you hold on for 5 years, there's a good chance that it will recover. What does that have to do with saving ourselves from large drops in stock price? – Bob Baerker Dec 08 '19 at 01:36
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    "By buying more" - you should probably emphasise this applies to the market as a whole, not individual companies. Stock prices of individual companies can just keep dropping until they reach 0. Experienced traders may use this information (combined with other signals) to predict individual prices, but it's risky and error-prone. For the market as a whole, as with any time you put money into the stock market, you should be prepared to leave the money there for at least a few years. It could drop further before increasing again and take long to recover. – NotThatGuy Dec 08 '19 at 14:39
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    @Bob Baerker: I suppose that depends on what you mean by "saving yourself". Obviously, if you don't want to risk experiencing large drops in stock price, then don't buy stock in the first place :-) If instead you want workable strategies for minimizing losses from large drops, then holding on until the price goes back up is usually a good strategy - especially when it's a general market drop, not just the particular stock. – jamesqf Dec 08 '19 at 19:12
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    @jamesqf - I think that it's quite clear that the OP isn't asking: "How do I recover from this huge loss that I experienced" but rather "How do I save myself and avoid a huge loss?" The proof in the pudding? The OP asked: "How do you protect your investment in such situations?" Protect doesn't mean ride a loser down. – Bob Baerker Dec 08 '19 at 19:53
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    Good covering answer. I would just add that as a private investor one should not rely on a strategy that requires quick reaction and instead focus on long term strategy. Unfortunately this boils down to two options: either sell with a loss after the market correction or wait things out (depending on your personal judgement of the future) – Manziel Dec 08 '19 at 23:21
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    "Largest investments should be ... major companies" -- where's the fun in that? :) – Barmar Dec 09 '19 at 06:48
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    "If you invest in a company that has been the market leader for 30 years, chances are it doesn't drop much in value" - tell that to Kodak shareholders. – Martin Bonner supports Monica Dec 09 '19 at 16:49
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    @MartinBonnersupportsMonica "chances are it doesn't drop" is not the same thing as "it doesn't drop". – user428517 Dec 09 '19 at 16:55
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    @Bob Baerker: And now we're trying to read the OP's mind, arguing about what he actually meant instead of what the question (somewhat ambiguously) says. – jamesqf Dec 09 '19 at 18:19
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    There's a long list of dominant companies that belong on that list with Kodak: Bear Stearns, Conseco, Lehman Brothers, Enron, Blockbuster, Sears, Worldcomm, et al – Bob Baerker Dec 09 '19 at 18:31
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    @jamesqf - You're the only one who is fabricating alternative meanings. The OP's question of "How do you protect your investment?" has a very clear meaning and is not ambiguous. – Bob Baerker Dec 09 '19 at 18:32
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The classic answer to that dilemma comes from Will Rogers:

  • "Don't gamble; take all your savings and buy some good stock and hold it till it goes up, then sell it. If it don't go up, don't buy it."

More practical ways of reducing losses are stop loss orders and options.

Bob Baerker
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    Except that stop loss does not work: https://money.stackexchange.com/questions/116805/about-sell-stop-loss-order – juhist Dec 07 '19 at 13:52
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    A stop loss protects you. However, it may not protect you to the extent that you want it to. – Bob Baerker Dec 07 '19 at 14:12
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    @BobBaerker not really. if the first deal after the news is at 50% loss, your stop-loss will be executed at that price. there is no magic that executes a sell for your trigger point, if nobody buys at that price. – Aganju Dec 07 '19 at 20:59
  • The large drop happens after the earning call and before a few minutes before the market opens. I observed this happening for AAPL and UBER in this year. It also happened for DAL when they announced that the fuel price is up during the market hours. – wonderful world Dec 08 '19 at 01:05
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    @Aganju - There's no guarantee that your order gets filled at 50% down. A stop loss gets executed at whatever price the market is at when your order reaches the front of the order book, not where the market opens after the gap. So as I said, a stop loss protects you. However, it may not protect you to the extent that you want it to. – Bob Baerker Dec 08 '19 at 01:29
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    @wonderful world - Most of the time, if there's a large change in price, it will occur immediately after the news is released, at any time during pre- and post-market trading. There's often some follow though when the market opens for regular hours trading because many people don't trade during after hour. – Bob Baerker Dec 08 '19 at 01:33
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    @BobBaerker , maybe I am reading you wrong, but no order gets 'executed' just because it is 'at the top of the order book' or because 'it likes to be executed' - there needs to be a buyer. If nobody buys, nothing gets executed. – Aganju Dec 08 '19 at 02:03
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    @Aganju - Not sure where 'it likes to be executed' came from but be that as it may, I think that we may be on the same page. XYZ is $50 and you have a stop loss order at $45. XYZ gaps and opens at $40 in a fast market. Precedence on the order book is price and time. If there are a lot or other orders ahead of you, they get filled first. With excess selling volume taking out the bids, price drops and the fill on your market order could be well below $40. That's what I mean by stop order protects you but may not protect you to the extent that you want it to.You're out but how much below $45? – Bob Baerker Dec 08 '19 at 04:02
  • @Aganju, have you looked at the volume charts as well as the price charts? When markets crash it's not because there was no trading at all during open hours. There are still sellers AND buyers; the buyers just aren't offering or paying as much. – quid Dec 08 '19 at 16:25
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By the end of the year, it was taken private at $196. You either need patience, or a magic trading formula that doesn't exist.

JTP - Apologise to Monica
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By not gambling, and instead investing in something with guaranteed returns (e.g. government bonds), an FDIC insured savings account, or ownership of something whose value to you remains the same regardless of what the market does (i.e. a house).

R.. GitHub STOP HELPING ICE
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  • How is a house's value independent from the market prices? – glglgl Dec 09 '19 at 08:44
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    since when are bonds guaranteed? lower risk, yes. No risk? No. – jiggunjer Dec 09 '19 at 09:32
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    @glglgl: Value to you of having a place to live (as stated in the answer). – R.. GitHub STOP HELPING ICE Dec 09 '19 at 12:13
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    @jiggunjer: Since forever. If you want to play the "well governments could refuse to pay them" game, that's true about currency too and you'd better go invest in canned food instead. – R.. GitHub STOP HELPING ICE Dec 09 '19 at 12:19
  • 'Value to you' has nothing to do with market value. Also, your answer should specify 'government bonds' not bonds because bonds implies corporate and/or government. – Bob Baerker Dec 09 '19 at 14:02
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    @BobBaerker: I've edited bonds. Regarding house, It's not supposed to have anything to do with market value. The point is that, as OP asked for, owning the place you live insulates you from large drops in value of other things you own that might limit your ability to obtain housing in the future. – R.. GitHub STOP HELPING ICE Dec 09 '19 at 14:18
  • Thanks for the edit. It clarifies the answer. I think that home ownership is a completely different topic that is tangentially related to stock market investment, which is not gambling when taken seriously. E.g. not penny stocks, etc. – Bob Baerker Dec 09 '19 at 14:26
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    @BobBaerker: Even if not a home (there are of course lots of good reasons not to buy one), ownership (and insurance) of the things you want to own long-term is a good mitigation for uncertainty of future value of things you might use to rent or purchase them later. – R.. GitHub STOP HELPING ICE Dec 09 '19 at 15:26
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    The way you phrase that, it equates stock ownership is gambling. As a blanket statement, that is wrong and DV-worthy. However, answers only exist in the context of questions, so it may be applicable to OP given the point-of-view of the question. Ergo no DV. This would be much improved by clarifying that it's gambling for OP. – Harper - Reinstate Monica Dec 09 '19 at 20:12
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You have a investment firm do it for you in a diversified account.

They have a team of specialist dedicated to monitoring stocks, and will know about things long before you get notified.

So now you have 15 different stock in one group monitored by a team of professionals.

Of course they do charge some sort of fee, but you won't lose everything.

cybernard
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  • Having you money managed doesn't protect against share price decline. – Bob Baerker Dec 11 '19 at 18:30
  • @BobBaerker It increase the odds against it dramatically. The funds manager see the company is declining or about to decline sells off ALL the shares. Now when they go bankrupt none of your money is in said stock. On the chance you do lose some money it will be a small percentage of your portfolio. I have had under performing fund groupings, but haven't actually lost any money after 20+ years. So if there is a problem with a stock the total interest rate for the whole group goes down so instead of 15% interest now you only get 10%. – cybernard Dec 11 '19 at 19:22
  • You can make the argument that fund managers have the ability to make better stock selections for you (that's debatable) but you can't make the argument that they can foresee that a company is about to decline. If that were the case, they and their investors would be rich since they'd never have any losers. Stocks often gap down and no one can predict that, not even the smartest quants at the best investment banks. Buying a low cost index ETF will achieve the same small loss percentage as managed money, except without the high management fees. – Bob Baerker Dec 11 '19 at 19:30