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A bear market need not be the worst thing if you have a couple of tricks up your sleeve. Here are a bunch of strategies that call for varying levels of risk appetite and expertise.
A bear market is a stock market scenario in which stock prices are falling pretty much across the board. In a bear market, investors typically panic and start dumping stock. This results in stock prices falling even further (since prices are a product of demand and supply) creating further panic.
Sounds horrible, doesn't it?
Well, actually; it depends.
It could be horrible if you already have stock market investments and had planned a few months ago to pull out your capital at this point, in order to fund an overseas education, or a big fat Indian wedding, or to buy a home or you had some plans for the capital at this specific point in time. Your capital is no longer worth what you had estimated because the stock prices have fallen.
However, a bear market need not always be a bad situation.
Here are 10 bear market trading strategies that can help you work this type of market scenario to your benefit.
Use it as an entry point for strong stocks
Especially if you are an outsider or a newbie investor, a bear market and its characteristic falling stock prices can be very alarming when you see it for the first time. However, stock prices have peaks and troughs and the stock market goes through highs and lows - that's just how it is.
In a bear market, stock prices fall across the board for whatever economic or social or political reason. However, as the economic or social or political situation eases up or returns to a state of normalcy, the stocks of strong companies bounce back as they revert to business as usual.
Savvy investors will wait for moments when the stock prices of strong companies fall, in order to buy at a lower than usual rate (or buy stocks that they otherwise might not be able to afford) and increase their chances of better profitability when the stock prices bounce back.
A word of caution: choose your stocks carefully and after a thorough look at their financial track record; avoid haphazardly buying "cheap stocks".
Dividend stocks
If a company is doing very well financially and is paying out dividends regularly, depending on the amount of the dividend (and whether or not it represents good return on investment) investors might want to consider investing in such companies.
Alternatively, when a company declares a dividend, there is a gap between the declaration and the payout. The stock prices usually spike during this period - you might get an opportunity to sell at your target price after all.
Focus on value stocks and essentials
Investors should try to understand the concept of P/E ratio or price to earnings ratio because they might be able to dig out companies whose earnings outweigh their price. In fact, if you toe this in with our first point, you can increase your chances of developing a strong portfolio.
Focusing on essentials like food, medicines and basic hygiene products is typically seen as a good way to invest in companies that will continue to do well because people are likely to need their products no matter what.
Short investing
Let's say prices have begun falling; panic and pandemonium rule the market. An investor might observe this and foresee that all this panic will only result in the prices being driven down even further. As a result, he might sell some stock he intends to actually hold on to and buy it back when the prices fall even further. This is known as selling short.
Consider using margins
If you want to buy into a bear market to make the most of falling prices, but do not have sufficient investment capital, you may consider margin trading where you put in a part of the capital and the broker puts in the rest.
A word of caution: margin trading is riskier than investing with your own capital.
Call option
When you buy a call option, you buy the right (but not the obligation) to buy the stock at a particular price by a particular date. If the stock price is currently Rs 100 and the trader expects the price to bounce back to Rs 120 in a few months, he might use the current fear in the market to get a call option for Rs 100 or Rs 80. He will usually not have a hard time getting such a call option in a bear market because people will be panicking about the stock price running into the ground.
Put option
Alternatively, if you're feeling less optimistic, you could buy a put option. This kind of options contract gives you the right (but not the obligation) to sell stock at a particular price by a particular date. Let's say the stock price is currently Rs 50 and you're expecting it to rise to Rs 45. You'll make a deal to sell the stock at Rs 48.
Government bonds
Depending on the rate of interest being offered, government bonds and muni bonds might be a good option for investing as the government represents a low default risk - you hardly expect the government to run off with your money irrespective of how the bulls and bears are trading.
Do nothing
Provided you have investments in strong stocks, and especially if you are a passive investor, sit tight and wait for the storm to pass. The stock market will usually bounce back after the factor that drove the bear market is resolved or becomes old news.
Day trading
Especially if you find yourself with more time on hand (and sufficient experience, confidence and disposable income), you could consider day trading where the trader attempts to benefit from small pricing changes throughout the day. He buys at a lower rate and sells at a higher rate but does so in high volumes - he'll make many trades in a single day and will also trade a large volume of shares. Day traders compulsorily sell all their shares by the end of the day.
A word of caution: You must understand technical analysis and have a sufficient risk appetite.
Conclusion
The various bear market trading strategies suggested here have varying levels of risk and traders must be prepared to understand and bear the necessary risk to access potentially higher profitability. Research more extensively about your chosen strategy before investing.
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