Investing in a Bear Market

Jun 22, 2022 Written by LAT Staff

If you have been an investor or trader for a significant amount of time, it is quite possible that you have experienced the frustration of trading during a bear market. Bear markets are inescapable for rookie traders. Many traders understandably fear bear markets. They can sap your vitality, undermine your confidence, and leave you feeling a mixture of desperation and pain. Markets bear sentiments that are overwhelming even for seasoned investors.

While we are not in a recession, the odds are slanted in that direction. As a result of global central banks increasing interest rates in reaction to very high inflation, investors are already concerned about the possibility of a recession. Hence, the probabilities are not favourable based on historical evidence.

To successfully navigate a bear market, it is paramount to cultivate your resilience and acquire as much knowledge as possible. After all, investing in a bear market is a tremendous opportunity, and it is possible to gain significant periods during these downward times.

Moving forward, we will explore the characteristics of bear markets and the best strategies that will show you how to profit in a bear market.

What is a Bear Market?

Overall, a bear market is typically characterized as a loss in the stock market of 20% or more, as measured by a broad index such as the S&P 500 or the Nasdaq Composite. The 20% criterion may appear arbitrary, but it is essential since it eliminates a significant number of painful but transient drawdowns for that asset type.

For declines more significant than 10% but less than 20%, we commonly refer to them as "bull market corrections." However, there are no universally accepted standards for declines of less than 10%. Selloffs of this magnitude are quite common, short-lived, and typically earn titles like dip, selloff, reversal, pullback, and slide.

Whereas rising prices inevitably followed every bad market in history, many portfolios damaged by bear markets took considerably longer to recover, and some never did. Capital preservation is the primary order of business in investing, and a bear market drives this fact home more effectively than anything else.

Nonetheless, beware of bear trap trading! A bear trap, or bear trap pattern, is a quick downward market movement that induces bearish investors to sell short, followed by an upward price reversal. Short sellers lose money when prices increase, prompting a margin call or compelling them to purchase back borrowed shares to cover their position.

The following are some indicators that analysts and economists look for to determine whether or not a market is in a bear market. When two or more of these conditions are present, a strong indicator is that a bear market is about to enter (or has already entered) the economy.

• Stocks prices begin to go down.
• Spending falls throughout the economy, which contributes to deflation.
• Corporate earnings decrease
• Pessimistic sentiments emerge among investors
• Investors sell their existing holdings and delay the purchase of more shares.
• Unemployment rate rises, and funding for research and development decreases.

How Long Do Bear Markets Last?

Since 1928, there have been 28 bear markets, with an average fall of 35.62%, as reported by Seeking Alpha. The average duration was almost nine and a half months or 289 days. While history is not a set-in-stone guide, if we use Seeking Alpha's logic, the current bear market might stretch until about March 2023.

However, this may be an optimistic outlook based on past bear market models. Since World War II, bear markets have averaged 13 months from peak to trough and 27 months to return to breakeven, according to research by ABC News published this week. During bear markets, the S&P 500 index has declined by an average of 33% during the last 20 years. During the bear market of 2007-2009, the S&P 500 lost 57% of its market value, the worst fall since 1945.

Bear Market Categories

There are a variety of distinct bear market kinds. These tend to have varying durations, effects, and thus, recuperation periods. This is since various bear markets result in various recessions, some of which are more detrimental to a nation's economy over time. This section examines the three most typical forms of bear markets.

  • Cyclical Bear Markets
Typically, a cyclical bear market occurs near the conclusion of an economic cycle when there are high inflation rates, increasing interest rates, and diminishing earnings. This has a negative impact on the prognosis for economic development and potential in the future. This kind of medium-term bear market decreases less than bad structural markets and typically lasts around 25 months.

  • Structural Bear Markets
Stock market bubbles and economic imbalances are related to bad structural markets. The global financial crisis of 2007-2009 illustrates a structural bear market. These sorts of bear markets are often associated with financial crises in which excessive debt loans are extended to people. A structural bear market has an average duration of 3.3 years and a recovery period of 9.0 years, making it the most protracted kind of bear market.

  • • Event-driven Bear Markets
Why is the market down in this case? This sort of bear market is influenced by worldwide financial catastrophes, such as wars, oil shocks, pandemics, and even terrorist acts. The Covid-19 virus and the 9/11 terrorist events are examples. Event-driven bear markets often have the smallest declines and recover the quickest, making them the shortest bear market type.

How to make money in a bear market?

Throughout a bear market, most investors lose money. Bear traders prefer trading on the downside, but they are fooled into believing the decline has ended before it has. Bulls, meanwhile, attempt to ride any upward trend to a profit but eventually give up and sell at the wrong time. Here are the best strategies that will allow you to make money during a bear market:

  • Regulate Your Emotions
When a market crashes, it is essential to recognize that the trend has shifted from bullish to bearish. It is human nature to look for scapegoats, find an explanation, or rationalize away the reality that the market trend has shifted.

Unless the trader recognizes that they are exclusively responsible for trading their way out of a negative market, thy will realize that their position is unsustainable and that they are incurring daily losses as the bearish market emotions persist. It is not profitable to refuse to accept responsibility for your own trading decisions and instead place the blame on your broker or a buddy who provided "advice" that resulted in your losses.

  • Short Selling
You may keep up with the directional momentum in a bear market by engaging in short selling. This involves taking a selling position, also known as going short, and predicting that market prices will continue to decrease. You stand to earn a profit off of your forecast if it comes true. However, even in bad markets, price swings may occur in either direction. Therefore, you will suffer a loss if the price movement swings in the opposite direction of your position.

  • Leverage Options
Trading options is yet another instrument that might be helpful in an investor's overall financial plan. Put options provide the owner with the ability to sell a stock at a certain price on or before a predetermined date. These options may be used as a hedging strategy against a decline in stock price. Call options allow investors to buy at a predetermined price with the expectation that the value of the underlying asset will increase in the future. This enables investors to purchase shares of a company at a price that is lower than its current market value and afterwards sell them for a profit. The striking price is often used in order to determine the contract price at which a derivative may be purchased or marketed for sale.

  • Dollar-Cost Averaging
Dollar-cost averaging represents the process of investing a fixed sum in a certain investment over time. Whenever the price of the investment is high, fewer shares will be purchased. When the price of the investment is low, more shares will be purchased. For instance, a passive investor may invest $100 monthly in a market-wide exchange-traded fund (ETF) such as SPDR S&P 500 ETF Trust.

If you consistently invest a specific amount in stocks, whether through Stocks ISA or any trading platform, you will purchase more shares as market prices fall and fewer shares as they rise, slightly improving your odds of success. Hence, making money in a recession is quite feasible. The advantages of dollar-cost averaging accrue in addition to the advantages of making monthly contributions to a tax-advantaged savings plan.

  • • Diversify and Distribute Risks
Diversification is a crucial component of any investing plan. Hold a combination of cash, fixed income, and stocks. Spread your investments across worldwide markets so that you are not overexposed to declines in any one region. Most importantly, ensure that you are at ease with your risk profile. This is the amount to which you are willing to watch certain assets decline in value in pursuit of better returns.

Diversification may protect against losses. In any bear market, some market sectors are likely to be affected worse than others. Hence, diversification inside the equities market as well as across asset classes is a preventative action you may take today since it is exceedingly difficult to predict them in advance.

Consider the assets you have put up for intermediate needs or objectives since diversification entails holding a broad range of investment-grade bonds, including corporate, municipal, Treasury, and even overseas offerings. Their maturities should range from short-term to intermediate so that you always have some bonds maturing and give you either income or funds to reinvest.

  • • Always Think Long Term
One of the worst things you could do in a bear market is respond impulsively to market fluctuations. The fundamental reason why the ordinary investor severely underperforms the general stock market over the long term is excessive trading activity.

When assets plummet and seem to continue plunging indefinitely, our natural inclination is to sell "before things get worse." Then, when bull markets occur, and stock prices continue to rise, we invest (after much of the rise has already happened) for fear of losing out on rewards.

It is common knowledge that the primary objective of investing is to buy cheap and sell high, but by emotionally responding to market fluctuations, you are doing the exact opposite. Invest in equities that you want to own for the long term, and do not sell them just because their prices have fallen during a bear market.

  • • Identify Strategic Opportunities
In a bear market, defensive equities, such as consumer staples, healthcare, and utilities, as well as firms with higher-quality operations and balance sheets, may provide possibilities. You may also discover possibilities in high-quality dividend-paying equities, particularly those with a history of continuous dividend growth; these may assist in enhancing your overall return when stock prices are declining.

  • • Take gains at predetermined periods

When there is a bear market, the most likely direction for price activity is downward. There is a possibility that this presents a chance to lock in gains on a regular basis; nevertheless, it is essential to keep in mind that even in bear markets, prices have the potential to rise on occasion.

Bottom Line

Bear markets are not a cause to worry about, but they are a good opportunity to ensure that your portfolio is appropriately diversified. Furthermore, you need to be aware of how much money is on the line and how much time you have to make up for any losses. After all, accepting personal responsibility will increase the likelihood of profiting under adverse market conditions.