A bear market occurs when a major index or exchange experiences a drop in value of about 20% from its most recent “52-week high”. An individual stock, commodity, or asset can “enter bear territory” if its price declines by 20% even though the rest of the index or market against which it’s measured could still be trading well.
Bear markets happen naturally. But they can also be triggered by “shock” events. Shock-based bear trends may not behave like natural bear trends. So you need to be careful about identifying why your market of choice has entered “bear territory”.
There are basically two styles of buying and selling financial assets: you can trade – where you “buy low, sell high” based on the movements in prices – or you can invest – where you “buy and hold” (for at least a year). Investors may want to sell stocks after their prices rise but tend to wait a year so they can pay only long-term capital gains taxes on their profits. But investors are more likely to care if a stock or asset pays interest or dividends.
How Investors Can Make Money In Bear Markets
Assuming you want to pursue a low-risk strategy, you want to avoid the popular strategy of averaging down. This is the bear market version of Dollar Cost Averaging, where you attempt to lower the average price of your shares in a stock or asset by buying at different pricing levels.
The averaging down strategy assumes you’re getting good prices as the stock or asset price plummets. But there are two disadvantages to this strategy.
First, your portfolio shrinks as you average down. The shares you buy continue to lose paper value. Advocates of this strategy argue that the price will eventually come back up when the market turns. But regardless of how long-term your investing perspective may be, if you are forced to sell those shares for any reason before the price recovers, you’re essentially throwing away money.
Second, there are no guarantees your asset prices will recover. You’re more likely to see a recovery if you average down on the price of a mutual or exchange traded fund. These funds diversify your investment and then generally recover with the market. But individual stocks or assets may not recover for many years, or they could eventually price down until they are dropped from the exchange.
1 – How Investors Can Easily Grow Their Portfolios
If you’re making regular contributions to your investing account then simply depositing that money into your cash or liquid asset account and leaving that money alone until the bear market bottom forms is the safest strategy. You’ll earn interest or dividends on this money. It won’t be much but your portfolio won’t shrink as fast.
2 – How Investors Can Leverage Some Risk
In every bear market there are usually assets whose prices remain relatively stable, and there may be some whose prices increase. For example, if the bear market is triggered by a recession then there will be “recession-friendly” assets.
In the stock market, recession-resistant stocks tend to be for those companies whose goods and services continue to sell as people lose their jobs. These kinds of stocks include food producers, service providers, and basic health providers.
Of course, there are no guarantees that economics work as you need them to. Government aid programs may expire or change their requirements. And unexpected disruptions may make some foods more expensive during a recession.
3 – Investors Can Change Investment Markets
Many large volume investors, when they pull their money out of stocks, move their cash into bonds. The bond market pays more predictable returns, although they tend to be lower than returns investors expect from the stock market.
Bond funds usually pay better than money market funds. So if you’ve accumulated a lot of cash from the start of the bear market you can explore bond market options for a better return.
Pay attention to the daily and monthly performance of any asset you’re thinking of investing in. If it’s not performing better than the market or its category then it’s not a good bear market investment.
How Traders Can Make Money In Bear Markets
As a trader you’re looking for opportunities to “buy low, sell high”. Those opportunities should still emerge from time to time. But trading is an inherently risky practice. You need a strong foundation in both cash and understanding how the markets work.
There are basically two ways that traders make money in bear markets. Traders pay more attention to trading signals, which are a vast array of statistical measurements that look at things like volume levels, moving averages, and more complex equations.
As a simple example, if an asset’s price is higher than its 10-day average, and the 10-day average is higher than the 50-day average, and the 50-day average is higher than the 200-day average, then the price is considered to be in “bull territory”. That is, it’s in a positive, rising trend.
Asset prices occasionally drop below these moving averages. But they may “bounce” off a moving average or a high volume level. These bounce points are called “resistance”, and traders may expect prices to bounce or to “break through resistance”. They set their price targets for buying and selling on the basis of how they interpret the various signals and trends.
1 – Traders Find Rising Assets In Bear Markets
There are usually a small percentage of assets whose prices rise while their general categories or entire markets are declining. Using signals analysis (aka “technical analysis”), traders identify stocks or assets that are moving against the market (or against the category). These movements may represent long-term trends or short-term events. Traders just want to get in when the prices are affordable and get out when they can make a reasonable profit.
Many traders sell off rising assets when they’ve increased by about 20% over their purchase price. This is how traders often take advantage of bear market bounces, where the indexes temporarily change direction and rise. Bounces happen for a variety of reasons, but often they are driven by retail (small) investors trying to buy assets at what they think are good prices.
2 – Traders May Sell On Margin
Margin trading, as it’s called, is where traders borrow shares from their brokers and sell them immediately. The traders must return those shares and they are counting on the prices going lower. This is called shorting the market.
Traders who short the market are hoping to make a profit by selling high, buying low. They don’t have to buy back at the bottom of the market – they only need to buy back when the price has dropped enough to ensure they’ll make a profit.
Brokers may demand return of the shares early if the prices change or drop too radically. This is called margin call. Traders who are unable to return the shares may lose their margin trading privileges. And being forced to return borrowed shares at the wrong price means the trader loses money.
3 – Traders Can Hedge Their Bets
Just because you’re trading in the market doesn’t mean that is the only way you’re participating in the market. You can hedge your investments in several ways.
First, you could continue investing in bear market-friendly assets. Many traders do this. Or they may hold positions in dividend- or interest-paying assets.
Second, you can trade in derivatives. Derivatives are a secondary class of assets built from the value of the primary assets. The most common derivatives are options. Options are contracts where someone promises to sell an asset at a specific price in the future, or they promise to sell the asset at a specific price in the future.
The option contract itself is sold. The person offering the contract is making money on the promise made. They may lose money if the contract buyer exercises the option in the future. Options trading can be complicated and it’s inherently risky.
Conclusion
There is always a way to make money in the markets. If there weren’t people wouldn’t be buying and selling the assets. For every buyer there must be a seller.
The sellers take the greater risks, in my opinion. Sellers risk losing money if they don’t set hard prices or stop-loss limits. And sellers may not find any buyers at the price levels they want, so they end up holding assets they no longer want.
Buyers take on some risk because they don’t know what’s going to happen to the asset price. But buyers who make informed decisions have at least some idea of what they are getting into.
There are arguments in favor of trading over investing and in favor of investing over trading. I prefer to invest rather than trade. But sooner or later you’ll need to get out of an asset. It’s better to pick the time you sell and the price at which you sell than to just let the market decide for you.