3 Ways to Attack a Bear Market for Profits
Updated: Apr 19, 2020
It's December 2018 and the Wall Street Bears are out, welcome to the bear market. A bear market is defined as a market or investment that has declined 20% from its high. While the overall markets are heading closer to bear market territory, many stocks are trading in bear market territory. Investors and speculators, experienced to novice will attempt to maneuver a down market in a number of ways. Here we provide three ways that an investor can attack a bear market.
1. Go Short
Going short in a bear market is the obvious strategy. For new investors who aren't familiar, it is when you sell an investment (that you don't own) with the expectation of buying the investment back at a lower price than you sold it. You can learn more about shorting here.
How Shorting Works
Short Sell 100 shares of ABCD @ $50/share
Buy/Cover 100 Shares of ABCD @ $25/share
Profit is $25 x 100 = $2,500
If the plan is to go short, there needs to be an exit strategy, specifically for the chance that the short goes against you. Everyone has their own thoughts on when and how to go short. For us, we like to short off of an area of support or resistance. See the diagram below.
In the first example in the diagram, the idea is to short when the stock fails to make a new high, with the hope that it continues to move down in price. Our exit strategy in this case if the short investment doesn't work out would be slightly above the peak (3). In the second example it should be noted that an area of support once broken can become an area of resistance. The idea in example two is to short the stock when it fails to break through resistance. The exit strategy in case we're wrong would be above the resistance area (4).
Shorting is very speculative, in theory a stock could increase infinitely, so if you're holding a short position of a stock that decides to start moving up you could lose a lot of money. For investors that don't have the ability to short investments in their accounts, they can buy a Put option on the investment. Buying a put will allow you to profit from an investment decreasing in price. You can learn about Put options here.
2. Sit and Wait
I know sitting, waiting, and watching the markets go down with you're money in it doesn't seem like a plan of attack but it can be. In this case you are sitting and waiting for the investment(s) that you may have missed out on earlier in the year or earlier in the bull run to come down to a price where you feel there is value.
The investor that sits and waits has money ready to purchase stocks that have entered their zone of value. To execute this strategy an investor has to have tremendous patience, and a decent knowledge of how to value a company doesn't hurt either. With the sit and wait strategy an investor is waiting for the stock price to come to them before they start purchasing shares.
3. Buy in Increments
Buying in increments is not for the faint of heart. This is a strategy that requires a lot of patience and an ability to watch your investment go down - possibly way down - before it goes up.
The key to investing in increments is to isolate good companies, not good stocks, but good companies. Good companies with good practices in good industries can survive a bear market, bad companies are more susceptible to collapse during bad times.
Once you've isolated a good company that is worth your investment dollars you buy a small amount of shares at various points. Maybe you buy at every two weeks or at every significant level of support. The idea is that instead of pouring all of your money into the investment at once, you buy shares gradually as the stock decreases in price.
If you normally invest $5,000 in a position, instead of buying $5,000 worth of stock at once, you'll buy $1,000 worth of stock at five different times or $500 worth of stock at 10 different times. In this case the max amount of money you could lose is $5,000, however if you're buying stock this way you should have a price for the investment that triggers a sell. No need to lose $5,000 if doesn't work out.
These are several ways to attack the bear market and/or stocks that are entering or have entered bear territory, these are just three of the simplest strategies. You can short stocks or buy puts and watch the cash pile up as the stock price goes down. You can sit and wait and make a move once you find investments that have entered your value zone. You can build a position as stock prices fall by buying in increments. How you decide to attack the bear market will depend on your level of comfort executing the strategies we've laid out.
Keep in mind that options one and three can be extremely risky. Before attempting to short or buy in increments it is important to have your exit strategy in place in case the plan doesn't work out.
I hope this helps you deal with the down markets. If you have an idea on how to attack the bear markets let us know.