Bear Market
A bear market is a period of time when prices in the financial market decrease. For an inexperienced trader, the bear market can be a very risky and difficult environment to trade. He may incur significant financial losses and lose the desire altogether to invest in financial markets. Why can this happen? Traders have a saying: “the market climbs the stairs but descends in an elevator.”
What does this mean? If prices start to fall, many traders tend to leave the market. They either cash out their money or take profits on long positions. Such a situation can provoke a domino effect, when some sellers leave the market; they are joined by those who exit positions even more strongly, etc.This drop will be even stronger if the market is heavily leveraged.
In a bear market, an investor usually shows a “bearish” mood, expecting a price decrease. This indicates that market sentiment is quite low (market sentiment — in simple words, it is the prevailing mood of market participants at a given time). But this does not mean that all market participants have active short positions. Participants are waiting for prices to fall and want to take an appropriate position.
What Else Could Trigger a Bear Market?
Government intervention in the economy of any kind can trigger a bear market. As an example, changes in tax policy can severely bring down markets. The bear market can drag on for quite a long time. The shortest bearish trend in the American market was during the coronavirus pandemic in 2020 and lasted for 33 days. And the bearish trend in the American market for the S&P 500 index lasted 517 days — almost a year and a half.
What Needs to Be Done Before a Bear Market?
There is no reliable way to determine that the market is going to start falling soon or that the decline that is already underway is the beginning of a bear market. You can use macroeconomic indicators; assess the level of volatility, and track P/E and CAPE ratios.
So, what can you do anyway?
- Diversify the portfolio.
- Use only free money for investing.
- Consider investing in defensive stocks. What is it? There are products and services that the consumer will not be able to refuse even during a crisis, for example, food, medical services, electricity. The revenue of such companies will remain relatively stable; their shares are considered defensive and will fall less in price during the crisis.
- Keep cash reserves available and seize opportunities. The bear market provides an opportunity to purchase good stocks at bargain prices.
- Hedge your positions. The diversification approach will smooth out volatility and drawdown, but will not be able to fully protect against them.
How to Trade In a Bear Market?
The simplest strategy in the bear market is to go into cash. If you don’t like the decline in prices, you can wait for the end of the bear market, and when bull market trends appear, you can return and take advantage of the profitable trend.
What to Do When Everything Collapses?
Either do nothing, or avoid panic selling. Do not sell assets you have held for years, and whose characteristics you were satisfied with at that moment. If there is free money, use it to purchase assets at a time when macroeconomic indicators will improve and there will be signs of a bullish trend.
Buy stocks regularly. A good option in any market is to purchase shares all the time, regardless of the price. For example, every month. This strategy is called Dollar Cost Averaging (DCA), or price averaging. As a result, the investor gets an average stock price, and it will still be profitable, since markets rise more often than they fall, and the fall is followed by the next growth cycle and new highs.
