Smart Strategies for a Bear Market

Fact checked by Diane CostagliolaReviewed by Robert C. KellyFact checked by Diane CostagliolaReviewed by Robert C. Kelly

A bear market refers to a widespread decline in asset prices of at least 20% from recent highs. Clearly, these times are nothing to look forward to, but fighting back can be dangerous.

Here we will walk you through eight important investment strategies and mindsets to help you stay calm and play dead when the stock market takes a swipe at your returns.

Key Takeaways

• Nobody wants to be caught in a bear market, but if you find yourself amidst falling stock prices, there are some strategies that you can put to use.
• You can take a practical and defensive posture, accumulating more shares in a regimented way as prices decline to pick up stocks on sale.
• You can also go on the offensive and take a short position in the market, profiting as prices decline.

Keep Your Fears in Check

There is an old saying on Wall Street: “The Dow climbs a wall of worry.” In other words, over time the Dow has continued to rise despite economic woes, terrorism, and countless other calamities. Investors should try to always separate their emotions from the investment decision-making process. What seems like a massive global catastrophe one day may be remembered as nothing more than a blip on the radar screen a few years down the road. Remember that fear is an emotion that can cloud rational judgement of a situation. Keep calm and carry on!

Accumulate With Dollar Cost Averaging

The most important thing to keep in mind during an economic slowdown is that it’s normal for the stock market to have negative years—it’s part of the business cycle. If you are a long-term investor (meaning a time horizon of 10+ years), one option is to take advantage of dollar-cost averaging (DCA). By purchasing shares regardless of price, you end up buying shares at a low price when the market is down. Over the long run, your cost will “average down,” leaving you with a better overall entry price for your shares.

Play Dead

During a bear market, the bears rule and the bulls don’t stand a chance. There’s an old saying that the best thing to do during a bear market is to play dead—it’s the same protocol as if you met a real grizzly in the woods. Fighting back would be very dangerous. By staying calm and not making any sudden moves, you’ll save yourself from becoming a bear’s lunch. Playing dead in financial terms means putting a larger portion of your portfolio in money market securities, such as certificates of deposit (CDs), U.S. Treasury bills, and other instruments with high liquidity and short maturities.

Diversify

Having a percentage of your portfolio spread among stocks, bonds, cash, and alternative assets is the core of diversification. How you slice up your portfolio depends on your risk tolerance, time horizon, goals, etc. Every investor’s situation is different. A proper asset allocation strategy will allow you to avoid the potentially negative effects resulting from placing all your eggs in one basket.

Invest Only What You Can Afford to Lose

Investing is important, but so is eating and keeping a roof over your head. It’s unwise to take short-term funds (i.e., money for the mortgage or groceries) and invest them in stocks. As a general rule, investors should not get involved in equities unless they have an investment horizon of at least five years, preferably longer, and they should never invest money that they can’t afford to lose. Remember, bear markets, and even minor corrections, can be extremely destructive.

Look for Good Values

Bear markets can provide great opportunities for investors. The trick is to know what you are looking for. Beaten up, battered, underpriced: these are all descriptions of stocks during a bear market. Value investors such as Warren Buffett often view bear markets as buying opportunities because the valuations of good companies get hammered down along with the poor companies and sit at very attractive valuations. Buffett often builds up his position in some of his favorite stocks during less-than-cheery times in the market because he knows the market’s nature is to punish even good companies by more than they deserve.

Take Stock in Defensive Industries

Defensive or non-cyclical stocks are securities that generally perform better than the overall market during bad times. These types of stocks provide a consistent dividend and stable earnings, regardless of the state of the overall market. Companies that produce household non-durables—such as toothpaste, shampoo, and shaving cream—are examples of defensive industries because people will still use these items in hard times.

Go Short

There are ways to profit from falling prices. Short selling is one way to do so, borrowing shares in a company or ETF and selling them – hoping to buy them back at a lower price. Short selling requires margin accounts, and could cause harmful losses if markets rise and short positions are called in, squeezing prices even higher. Put options are another choice, which gain value as prices fall, and which guarantee some minimum price at which to sell a security, effectively establishing a floor for your losses if you are using it to hedge. You will need the ability to trade options in your brokerage account to buy puts.

Inverse exchange-traded funds (ETFs) also give investors a chance to profit from a decline in major indexes or benchmarks, such as the Nasdaq 100. When the major indexes go down, these funds go up, allowing you to profit while the rest of the market suffers. Unlike short selling or puts, these can be purchased easily from your brokerage account.

Why Is it a Good Idea to Keep Investing Through Bear Markets?

Over the long run, the stock market tends to go up and the economy grows. While bear markets may interrupt this otherwise bullish trend, these downturns always have ended and ultimately reversed, reaching new highs. By investing through bear markets, you can buy stocks when they are priced lower (“on-sale”) and accumulate stronger positions.

How Often Do Bear Markets Occur?

Historically, bear markets in the U.S. occur, on average, every 4.5 to 5 years.

Why Is it Called a Bear Market?

There are a few competing theories of where the terms bull and bear markets came from. One is from the fact that bulls tend to attack by goring their horns upward; bears, instead, often attack by bringing their claws downward. Another theory argues that the term “bear” originates from the early fur trade, where bearskins were seen as particularly risky commodities in terms of their price and durability.

What Was the Steepest Bear Market to Date?

So far, the steepest and longest bear market was the slump from 1929-1932 that coincided with the Great Depression.

The Bottom Line

Bear markets can be fast and unforgiving. They are defined as a prolonged period of downward trending stock prices. But bear markets never last, eventually the market will find a bottom and market participants will reenter the market, pushing prices higher. It is wise to bear this in mind so that whatever your strategy for staying in a bear market, you avoid the temptation of selling at the low.

Read the original article on Investopedia.