Sometimes the investment weather forces you to 'buy a coat,' says Robert Prechter

When it's sunny, you head outside without a thought, but when it's rainy, you look for your umbrella.

When the markets are trending up, you don't worry about your investments much, but when the markets turn bearish ... what do you do?

In an interview with Jeff Sommer of The New York Times in July 2010, Robert Prechter said that he is convinced that a "market decline of staggering proportions" is on its way, and that individual investors should get out of the market and into cash and cash equivalents, such as Treasury bills.

"I'm saying: 'Winter is coming. Buy a coat,'" Prechter said. "Other people are advising people to stay naked. If I'm wrong, you're not hurt. If they're wrong, you're dead. It's pretty benign advice to opt for safety for a while."

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.

1. Stocks May Go to Near Zero

In 2000 and 2001, countless Internet stocks fell from $50 or $100 a share to near zero in a matter of months. In 2001, Enron went from $85 to pennies a share in less than a year. These are the early casualties of debt, leverage and incautious speculation. Countless investors, including the managers of insurance companies, pension funds and mutual funds, express great confidence that their "diverse holdings" will keep major portfolio risk at bay. Aside from piles of questionable debt, what are those diverse holdings? Stocks, stocks and more stocks. Despite current optimism that the bull market is back, there will be many more casualties to come when stock prices turn back down again.

2. Stock Mutual Funds Will Fall, Too

Not only will many stocks fall 90 to 100 percent, but so will a substantial number of stock mutual funds, which cannot exit large equity positions without depressing prices and which have the added burden to you of one percent (or more) annual management fees. The good news is that we will finally find out who the few truly good fund managers are and which ones were heroes by virtue of being around for a bull market.

3. The Fed Won't Be Able To Save the Stock Market

Don't presume that the Fed will rescue the stock market, either. In theory, the Fed could declare a support price for certain stocks, but which ones? And how much money would it commit to buying them? If the Fed were actually to buy equities or stock-index futures, the temporary result might be a brief rally, but the ultimate result would be a collapse in the value of the Fed's own assets when the market turned back down, making the Fed look foolish and compromising its primary goals, as cited in Chapter 13. It wouldn't want to keep repeating that experience. The bankers' pools of 1929 gave up on this strategy, and so will the Fed if it tries it.

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This article was syndicated by Elliott Wave International and was originally published under the headline 3 Reasons Now is Not the Time to Speculate in Stocks. EWI is the world's largest market forecasting firm. Its staff of full-time analysts led by Chartered Market Technician Robert Prechter provides 24-hour-a-day market analysis to institutional and private investors around the world.