Making Money During a Bear Market - a Trap or an Opportunity?

Jun 29, 2022 Written by LAT Staff

Although this may seem counterintuitive, bear markets are one of the finest periods to invest. If there is one thing about the stock market you need to know, it is that it has a very high chance of making a full recovery from even the worst downturns.

Moving forward, we will explore the smartest trading strategies that would allow you to reap the benefits of a downturn market.

But first, what is a Bear Market?

Before delving into the deep end of trading, we should clarify quickly what bear markets are. Overall, a bear market occurs when a market endures extended price decreases. “It often depicts a circumstance in which securities prices decline % or more from recent highs amid widespread pessimism and negative market sentiment.

Now, let’s proceed with the strategies that will help you fill your pockets (literally or not)!

Engage in short selling

Short selling is a strategy to follow the directional trend in a bear market; you would speculate on lower market prices by taking a sell position (going short). If your view is accurate, you will benefit. However, even in negative markets, prices may move in either direction. Therefore, you will suffer a loss if the price movement swings back up, against your position.

As the S&P 500 reflects a basket of underlying equities, shorting this market index is a popular option among traders. Their appeal is based on their accessibility to most traders as well as their technical and highly tradable tendencies.

Exchange-traded funds (ETFs) represent marketable securities that follow a portfolio of securities, a stock market index, a bond, or a commodity. Typically, ETF trading offers more liquidity and cheaper costs than mutual fund trading, making them a popular alternative for traders seeking to short a down market. Inverse ETFs are an excellent tool for both speculative profit-seeking and portfolio protection.

Don’t Forget about Day trading

In the financial market, there are three possible actions. You may engage in day trading if the projected length of a deal is shorter than a day. Second, you may encounter swing trading, where you initiate transactions for a few days. Finally, you might opt to become a long-term trader (more often called investing, not trading) by entering deals with a duration of many weeks or months.

We suggest using a day trading approach to profit in a bear or highly volatile market. This is because it will protect you from major market fluctuations. For example, if important information is about to be released, such as non-farm payrolls, day trading will assist you in avoiding getting caught in a transaction.

Higher Risk Appetite? Choose Margin Trading

Margin trading (also called trading with leverage) involves using borrowed cash to purchase securities from your broker (also referred to as a margin loan or simply “margin”). Remember that anytime you use margin, you introduce an element of conjecture. Buying 100 shares of a dividend-paying company with 100 percent of your own money is an excellent investment strategy, however, buying the same stock on margin increases the risk involved.

Even if you constantly monitor the market, you may want to place limit orders, trailing stops, and other trading orders on your short sell to restrict your risk exposure or automatically lock in gains at a set level.

Traders might execute a stop order transaction to minimize losses in case the market swings against them. Stop orders and trailing stops are used to shield short sellers from incurring unmanageable losses. A stop order automates the repurchase of shares when the stock price climbs over the stop price. In a trailing stop order, the stop price “trails” lower as the stock price declines (this can be done manually by you or set to trail automatically), limiting the potential risk on the trade and ultimately locking in a guaranteed profit (if the stop order level falls below your initial selling price).

Perceive Volatility as your Ally, not your Enemy

Volatility is not necessarily negative, as it may often give investors quicker profits. However, in volatile markets, profits may quickly evaporate and turn into losses, so it’s important to explore measures to lock in some profits wherever possible. One solution would be to set multiple profit targets for your trades, so (if you had bought a certain asset) you can sell some of your position as the price rises, locking in profits and limiting risk, but keeping some of the position in place to extract maximum gains from the remainder.

In volatile markets, you can take long (buy) or short (sell) positions, which allows you to take a bullish or bearish view of the price of an asset. This gives you more trading alternatives since you can profit from both bullish and bearish markets. If a market is falling, you don’t need to simply ait for it to fall before buying… you can actively sell at a high price and take profit if the price falls.

Well, you may ask yourself how long you should maintain a short position. Traders may initiate and exit a short sell on the same day or hold the position for many days or weeks, depending on the securities’ trading strategy and performance. Due to the importance of time and the possible effect of tax treatment, short selling is a technique that demands skill and vigilance.

Invest in Defensive Stocks

It is advisable to educate yourself on the 11 distinct sectors of the S&P 500 and to be prepared to long-short different industries throughout the day. Diversification is essential in active trading so that you are not dependent on a small number of stocks. Even if you are the best trader in the world, your success will be restricted if you only trade a few daily stocks.

If you wish to tame your risk-taking approach toward trading, investing in defensive companies is a wise strategy to protect your capital. These are shares of firms that produce consumer goods, whose products are in continuous demand regardless of economic conditions. Food and beverage makers are a typical example of this kind of company.

When the economy is thriving, investors seek to purchase “cyclical stocks.” These are shares of firms that make less-necessary things such as electronics, automobiles and other machinery. These firms’ stocks often do well in a bullish environment.

Conversely, savvy investors seek to purchase shares in firms that generate consumer necessities in a slowing economy. This protects their assets and allows them to profit (or certainly lose less) in a down market.

Bottom Line

A bearish market is not necessarily a bad thing for astute traders. The value of asset markets such as equities and cryptocurrencies tend to fall much faster than they rise, so this provides short sellers with an opportunity for substantial – and fast – profits. For investors with long-term portfolios, it may not be practical to liquidate all of your positions during a downtrend, but it is certainly possible to take advantage of the downtrend by short-term short-selling to recoup some or all of the potential losses in your longer-term portfolio