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While most investors think they are fully prepared for market crashes, this is easier said than done. Investors should always keep a part of their portfolio in cash and avoid the temptation of leverage. During market crashes many investors sell their stocks, usually the most profitable ones, even though their fundamentals have remained intact. This is a huge mistake. As Warren Buffett says, macro fears should never play a role in decisions to sell stocks. After 4 years of remarkably low volatility, the global markets crashed a few days ago, with S&P (NYSEARCA: SPY ) losing 200 points (about 10%) in just 4 sessions. The main reason was the increased concern that the Chinese economy might be decelerating from its current pace of about 7% annual growth. While most investors think they are fully prepared for such incidents, this is easier said than done and hence their mindset is really tested only when such events occur. In this article, I will provide a few guidelines for handling market crashes. First of all, investors should always keep a part of their portfolio in cash just for such incidents, which may be either widespread or specific for a single sector or stock. Investors normally prefer to be fully invested instead of keeping some cash because the latter results in underperformance during the good times of the market, as cash earns nothing. As the stock market does well most of the times (it rises slowly and falls steeply), it is only natural that investors tend to minimize their cash position. However, when a crash occurs, the resultant bargains are so great that they can provide exceptional profits in just a few days or weeks. Therefore, it pays to maintain a part of a portfolio in cash. For instance, Johnson & Johnson (NYSE: JNJ ), the popular dividend aristocrat that has raised its dividend for 53 years in a row, initially plunged 15% on Monday, August 24th, only to fully recover after 3 days. In a similar fashion, Gilead Sciences (NASDAQ: GILD ) initially plunged 18%, from $105 to $86, only to recover after 2 days. It is remarkable that its low of $86 corresponded to a forward P/E=7.4, extremely low for such an exceptionally managed, growing company. Similar trends were witnessed for other stalwarts as well, such as Visa (NYSE: V ), which initially plunged 16% on Monday, and MasterCard (NYSE: MA ), which initially plunged 19% on Monday. Both credit card companies fully retrieved their losses in 2 days. Instead of keeping some cash, some investors prefer to go to the other extreme and use some leverage in their portfolio. This is particularly enticing, as leverage helps them outperform the market during good times, i.e., most of the time. However, in the case of a crash, they will not have any spare money to take advantage of the rare opportunities that show up. Even worse, they may be forced to liquidate some positions at the most unfavorable moment. Therefore, not only do they miss the rare opportunities that emerge, but they also incur real, permanent losses due to the forced liquidation. In a mild market crash, like the one of last week, leveraged investors may lose profits of many months or years, depending on their degree of leverage. One might say that a 10% plunge can be tolerated even by high-leveraged investors but the truth is that no-one ever knows at what point the dive will end and hence high-leveraged investors are emotionally forced to liquidate positions even if they avoid a margin call. To put it simply, they prefer to cut their losses early, as a further decline of their stocks might be devastating for their portfolio. Apart from being fully invested, a common mistake during market crashes is to sell some stocks, particularly the most profitable ones. This is a huge mistake, which can prove to be very costly. If the fundamentals of a good stock have remained intact, the stock should not be sold during a market crash. Fears of an imminent recession or deceleration in the Far East or even the US do not count as fundamentals. If some investors are scared every time the media call for an imminent recession, these investors should never buy any stocks, as one thing is sure; a recession will show up in almost every country every few years. Therefore, selling solid stocks in a market sell-off is a recipe for failure. It is also a certainty that stocks with strong fundamentals will rebound quickly after the panic subsides and hence they will not be available near the prices recorded during the panic. To sum up, investors should keep a part of their portfolio in cash and avoid the temptation of leverage in order to take advantage of a market crash. Moreover, as long as the fundamentals of their stocks have remained intact, it will be a huge mistake to sell them. As Warren Buffett says, macro fears should never play a role in decisions to sell stocks. As the experience of all the previous market crashes (e.g. 1987, 2000, 2008, 2011) has shown, all the stocks with strong fundamentals soon retrieved their losses and most of them did so much faster than the market. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.