Nine Tips for Dealing With a Bear Market
Why you should avoid the panic freeze and view selling as 'insurance' and more ways to come out ahead in bad times.
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Current market action doesn't meet the threshold for a bear market, which is a 20% drop in the indexes, but a large percentage of stocks are already broken and in their own little bear markets. It is pretty clear that the potential for prolonged market struggles in the months ahead as the artificial intelligence theme matures and the economy slows.
Navigating bear markets effectively is the most important thing you can do to produce superior long-term investment returns. If you avoid large drawdowns and don't have to spend unproductive time and effort recouping losses, you can produce bigger gains, and the power of compounding will propel your returns. Keeping the losses small in a bear market is the key to success for all great investors.
Here are nine tips for navigating a bear market:
1. Stop the Bleeding and Break the Inertia. The biggest losses in a bear market are caused by inaction. There is an inclination to freeze and do nothing when stocks suddenly drop. We just sit and hope that they will quickly recover. In a bear market, no stock is safe, and it can quickly deteriorate. Failing to sell promptly can lead to deeper losses. Force yourself to do something. Any action at all will help break the inertia, and that is the most important thing you can do.
2. Think of Selling As Insurance. The easiest way to reduce risk in a bear market is to sell your stock and then buy it back when conditions improve. It is a very simple concept to understand, but most investors are resistant to it. There is a mental block when it comes to undoing a sale you just made. Think of it as just a form of insurance. If you end up rebuying the stock at a higher price, then you simply pay an insurance premium. If you buy it again at a lower price, then you are already ahead of the game.
3. Stay Patient and Avoid Calling the Bottom. Bear markets often end subtly rather than with a dramatic crash, contrary to popular belief. Trying to predict the exact bottom usually leads to premature buying and further losses when stocks don't do what we want them to do. Waiting for signs of strength and using recent lows as stop-out points to reduce risk.
4. Adapt to Unique Market Conditions. Every bear market is different, and there's no one-size-fits-all strategy. Some bear markets feature uneven declines, with certain sectors topping out earlier than others. Rotational corrections can provide very good opportunities if you are aware of what sectors are leading and lagging.
5. Trade Counter to the Trend. While shorting is always an option in a poor market. Bear markets tend to produce very energetic and sizable countertrend bounces. The biggest moves come in the worst markets. These opportunities require tight trade management and quick exits, but they can be very profitable if you are aggressive.
6. Use Technical Indicators. Moving averages can be very helpful for trade management in bear markets. Use 10-day or 21-day simple moving averages (SMAs) as stop-out points and look for long setups when stocks move above those points.
7. Focus on Cash Preservation. The biggest problem most investors face in a bear market is that they have too much cash invested and are unable to take advantage of the many new opportunities that are developing. Keep adjusting position size so that they don't grow too big. When market conditions improve, you want to be in position to put large amounts of cash to work.
8. Manage Emotions and Avoid Predictions. Bear markets take an emotional toll, and your worst enemy is yourself if you lack a plan. Don't get caught up in predicting market movements or trying to call a bottom. Focus on managing individual stocks and let those stocks be your guide to the health of the market. Stay focused on price action and ignore the 'experts' who are always making predictions.
9. Cultivate Optimism. The most important thing to do in a bear market is to stay optimistic. Not optimistic that the market is going to go up but optimistic that there is a pile of new opportunities developing that you will be able to trade. The great thing about bear markets is that they create substantial mispricing in individual stocks. When conditions improve, those stocks are eventually discovered, which leads to big gains.
Bear markets are inevitable, but if you handle them in the right way, they can be the foundation for exceptional returns.
At the time of publication, DePorre had no position in any security mentioned.
