For the investors risking their hard-earned money, the thought of a bear market may sound fearsome. However, bear markets are a part of the stock market life cycle and cannot be avoided. The stock market is dynamic and cannot remain either bullish or bearish forever, making it important to plan your bear market investing strategies beforehand. Following the correct bear market strategies can help you stay immune to the potential losses during the bear market situation. This article talks about the most effective bear market trading strategies.
What is a bear market?
Before diving deep into the strategies for a bear market, it is important for you to know what bear markets are?
A bear market is a situation where the overall prices in the stock market or the index prices witness a constant decline over a long period of time. A stock market is generally considered to be bearish when the stock prices fall by 20% or more in recent times, accompanied by negative investor sentiment. The constant fall in price attracts investors to buy more stocks, finally bringing an end to the bearish market.
Investment strategies for a bear market
There are strategies that can help you keep your investments safe in a bear market condition.
Remember, no situation is permanent. Bearish market conditions cannot stay forever and will surely rebound. Re-allocating your existing resources into better and safer options is the best way to avoid the ill effects of a bear market. While selling out your investments might look like a good option, this might make you miss out on the potential gains when the market rebounds. Keeping a balance between selling your investments to hold cash and restructuring your investments by investing into short-term government bonds or short selling to gain from falling markets. You should chalk out a plan and segregate your investment goals as short term and long term and plan your investments accordingly.
You can opt to play defensive by investing in large-cap companies with a long industry presence and strong balance sheets having high profitability. Large-cap companies are less vulnerable to the fall in the stock index and will likely come back strong during the bull market. Small companies might find it hard to sustain the falling prices, therefore, it is a smart move to shift your investments into large companies from small companies. You can also plan to invest in companies producing necessities like food and medicine as their business will continue even in the downtime.
Average out your costs
If you are a long-term investor, dollar-cost averaging is one of the best bear market trading strategies. Dollar-cost averaging involves buying more shares of the same stock at lower prices to reduce the overall cost per share. Say you have 100 shares of ‘X’ company at Rs.1000 each, and due to bear markets, the price falls to Rs.700 per share. You can use the dollar-cost averaging method and buy 100 more shares at Rs.700. Now your average cost per share becomes (100*1000) + (100*700) / 200, i.e., Rs. 850, which is lower than 1000. This strategy is the most effective if you are a long-term investor and have more resources to invest.
We have heard our elders say that you should not put all your eggs in one basket. This holds true for your investments too. Portfolio diversification is a strategy where you keep a balance between risky stocks and less risky or stable stocks. You can consider diversifying your portfolio by investing in government bonds, debentures, or other financial instruments to ensure the safety of your funds. In case of an economic slowdown and crashing stock prices, a rise in bond prices can provide some relief.
Having enough cash to restructure your investments or average out your costs can help you stay immune to the price crash in a bear market. It will manage your investments and also help you manage your day-to-day living expenses in case of a financial crisis. If you have sufficient money in your bank account to take care of a year’s living expenses, you can stay calm in difficult times.
Carefully select stocks to buy
During an economic slowdown, it is important that you select your stocks very carefully. You should opt for industries producing necessary products like pharma, petroleum, Agri products, etc. Select large-cap stocks as they are relatively stable in nature and are less likely to get affected by the bear stock markets. Analyze the previous trends and find out stocks that have a history of performing well during the recession and invest in them.
Short selling is a method of investment where the investor sells the borrowed stocks and buys them later at a lower price to earn profit. Short selling is also a great bear market trading strategy if you have a very high-risk tolerance. Short selling is risky and can cause losses if the market price starts rising.
Bear markets are a part of the stock market life cycle and are not permanent in nature. Looking at the falling share prices can be a major disappointment and lead to huge losses, but it can be effectively managed if you follow the bear market investing strategies mentioned in this article. You can also take professional help from experienced investment managers to save yourself from potential losses and keep enough cash in hand to tweak your investment portfolio for bear market situations.