A bear market is traditionally defined as a period of negative returns in the broader market where stock prices are down 20% or more from recent highs. Various strategies can be used when investors believe that this market is about to happen or is happening; The best approach depends on the investor’s risk tolerance, investment time horizon, and overall objectives.
- There are several strategies for dealing with a bear market, defined as sustained periods of downtrend stock prices, often triggered by a 20% market drop.
- Collecting all positions is one approach.
- Buying defensive stocks – stable, large-cap companies, especially those involved with consumer staples – is another.
- Yet another strategy is to go bargain hunting, taking advantage of depressed prices to grab fundamentally strong stocks.
One of the safest strategies, and the most extreme, is to sell all your investments and hold cash or invest the proceeds in much more stable financial instruments, such as short-term government bonds. By doing this, an investor can reduce his exposure to the stock market and minimize the effects of the raging bear.
That said, most, if not all investors do not have the ability to accurately time the market. Selling everything, also known as capitulation, can cause an investor to lose the bounce and lose the silver lining.
For those who want to profit from a declining market, short positions can be taken in a number of ways, including short selling, buying shares of a reverse ETF, or buying speculative put options, all of which will increase in value. as the market shrinks. Keep in mind that each of these short strategies also comes with its own unique set of risks and limitations.
For investors looking to hold positions in the stock market, a defensive strategy is generally taken. This type of strategy involves investing in large companies with strong balance sheets and a long operating history and track record: stable large-cap companies tend to be less affected by a general downturn in the economy or the stock market, causing prices to of their actions are less susceptible. to a major drop.
These so-called defensive actions also include companies that serve the basic needs of businesses and consumers, such as basic foods (people continue to eat even when the economy is in a recession), utilities, or producers of other basic goods such as toiletries. With strong financial positions, including a large cash position to cover ongoing operating expenses, these companies are more likely to weather recessions.
On the other hand, it is riskier companies, such as small-growth companies, that are typically avoided because they are less likely to have the financial security necessary to survive recessions.
Protection put options
A great way to play defense is to buy protective put options. Puts are option contracts that give the holder the right, but not the obligation, to sell a security at a predetermined price once or before the contract expires. So if you own 100 shares of the SPY S&P 500 ETF starting at $ 250, you can buy the $ 210 strike options that expire in six months, for which you will have to pay the option premium (option price).
In this case, if the SPY falls to $ 200, you retain the right to sell shares at $ 210, which means that you have essentially locked $ 210 as your floor and stopped any further losses. Even if the price of SPY falls to just $ 225, the price of those put options may increase in market value as the strike price is now closer to the market price.
The bear market that started on March 11, 2020 was possibly caused by many factors, but the immediate catalyst was the spread of the COVID-19 pandemic.
A bear market can be an opportunity to buy more stocks at cheaper prices. The best way to invest may be a strategy called dollar cost averaging. Here, you invest a small, fixed amount, say $ 1,000, in the stock market every month, regardless of how shady the headlines are. Invest in stocks that have value and that also pay dividends; Since dividends make up a large chunk of stock earnings, owning them makes bear markets shorter and less painful for the weather.
It is also valuable to diversify your portfolio to include alternative investments whose performance is not correlated with (that is, contrary to) the stock and bond markets. For example, when stocks crash, bonds tend to rise as investors seek safer assets (although this is not always the case).
The bottom line
These are just two of the most common strategies adapted to a bear market. Most importantly, understand that a bear market can be very difficult for long investors because most stocks fall during the period of a bear market, and most strategies can only limit the amount of exposure to the downside, not remove it.