A bear market refers to a sharp drop in the price of securities. The overall negative perceptions can lead to further consolidation of sentiment. As investors expect losses and sell-offs in the bear market to continue, pessimism increases day by day. Although the numbers may vary, the decline in multiple broad-cap indexes is 20% or more for many people.
When stocks start to fall, it is difficult to know when they will bottom out. If you wait too long, the stock goes up. However, you will miss the opportunity to buy on dips and not profit from the rebounding price. But if you pull the trigger too quickly, you may see your new stock purchases continue to decline. It can be tricky to determine the best time and manage active trading at the beginning of a bear market.
Usually, investors may withdraw funds when a bear market occurs to avoid falling yields or reduce losses. As investors’ negative sentiment rises, prices may fall further, making trading in a bear market risky. This could also lead to rising unemployment, falling consumer spending, and deflation.
Overall, what causes the bear market? Well, just like in a bull market, the occurrence of a bear market is affected by the relationship between supply and demand. In a bear market, supply is high, and demand is low. In a bull market, the opposite is true.
This article will provide you with several practical strategies to teach you how to act in a bear market.
1. Look for the assets with rising prices when the market is in the Bear position
It is helpful to study past bear markets to understand which stocks, sectors, or assets had actually risen (or at least maintained their levels when the markets around them were falling).
Sometimes precious metals, such as gold and silver, will outperform the market. Food and personal care stocks-often referred to as “defensive stocks”-usually perform well.
Sometimes bonds will rise as stocks fall. Sometimes, a particular market sector, such as utilities, real estate, or healthcare, may perform well, even if other sectors are depreciating.
Many financial websites publish industry performance in different periods, and you can easily see which industries are performing better than other industries at the moment. Start allocating some cash in these departments because once a department performs well, it will usually perform well for a long time.
2. Buy short-term and long-term put options
If you think that a bear market is developing and hold many long positions in the market, buying cheap short-term and long-term put options on major indices can be a helpful strategy.
A put option is an option that represents the right to 100 shares, has a fixed length of time before expiration, is worthless, and has a specified selling price.
Since options increase or decrease by a much larger magnitude than stocks, even a small amount of put contracts can offset your losses on long stock positions. As the expiry date approaches, you can choose to sell your put options on the open market or exercise and give up the stock.
3. Sell naked puts while trading in the Bear market
Selling naked puts involves selling put options that others want to buy in exchange for a cash premium. In a bear market, no shortage of interested buyers should exist.
You want the put option to be worthless at or above its strike price when you sell a put contract. If so, you make a profit by keeping all the premiums, and the transaction ends.
However, if the stock price is lower than the strike price and the put option holder exercises the option, you will be forced to deliver the stock at a loss.
The premium does provide you with some downside protection. For example, suppose you sell a put option on July 21 at a strike price of $10 and pay you a premium of $0.50. This provides you with a cushion as low as $9.50 to maintain breakeven.
You are on the receiving end of derivatives trading for naked puts, so the best strategy is to continue to sell short-term put options of robust companies. If you must, you don’t mind owning these companies, especially if they pay dividends. Even in a bear market, there will be times when stock prices increase, allowing you to profit from these short-term put option sales. But please note: If the market continues to fall, those short put options may cause you huge losses.
4. Set a stop-loss order
A stop-loss order is an order that you can automatically exit the position once you reach a specific unfavorable price. Therefore, if you are short-selling, the price of your stop-loss order will be higher than the price at which you opened the position, and vice versa if you are long-selling. If the market is not suitable for you, this risk management strategy can help you reduce your losses.
5. 5Trade with indices and ETFs in the Bear market
Although indexes such as the FTSE 100 represent a basket of stocks in a company’s market capitalization, exchange-traded funds (ETFs) track the performance of the market, such as a country’s stocks, indexes, or industries. Since bear markets are usually triggered by supply and demand factors, which affect economic conditions, broad exposure to related assets provides an opportunity to benefit from the expected similarity of price changes. Of course, if actual price changes run counter to expectations, this will result in losses.
Bottom line
To sum up, the bear market is one of the most unpleasant market positions for investors. Inexperienced traders might find it challenging to benefit somehow or not lose in this position.
However, mentioned strategies might help you survive while the market enters the bear position.
If you are still a beginner, try to reach experienced traders or advisors to act smart or do the research. We wish you a great trading experience.
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