The Best Way to Invest in a Bear Market
The problem does not come alone: the coronavirus pandemic has caused unprecedented problems in the world economy, the consequences of which will be felt by people around the world in the coming years. The new economic crisis announced by the International Monetary Fund could be the largest and most serious since the Great Depression of the 1930s. And the date and consequences of its end are almost impossible to predict, as the coronavirus pandemic is still ongoing.
The decline in stocks and the collapse of the oil market, the depreciation of major world currencies are by no means all the consequences of a global pandemic of the Chinese virus. Still, traders can take advantage of the bear market investment in assets that have bottomed out and will definitely recover. Learning to trade in the bear market is vital for all who want to take over the investment portfolio and get lucrative profits from the bear market.
In this article, we will learn what a bear market is, how to differentiate it from a bull market, as well as how to trade in bear markets using different types of assets.
What is a bear market?
A bear market is the state of the market, in which asset prices are falling, and generalized Pessimism leads to a negative autonomous mood. While investors expect losses in the bear market and sales continue, pessimism only increases. Although the figures may change, for many, a decline of 20% or more in some broad market indices such as the Dow Jones Industrial Average (DJIA) or The Standard & Poor’s 500 (S & P 500) in at least two months is considered an entry into a bear market.
When it comes to a single company, it is possible to judge the stage of the market in which it is located by looking at the price chart of its shares. For example, a Tesla stock chart:
What is a bear market?
As you can see from the chart, the period from November 2018 to July 2019 was the most bearish.
When it comes to the stock market in general, you can rely on the charts of so-called stock indices. After all, it is known that stock indices are based on the stock prices of companies, the most typical market representatives.
For example, let’s look at the chart of the S & P 500 index:
It is based on the stock prices of 500 largest companies listed on the largest U.S. stock exchanges. Thus, we can say that its chart reflects the state of affairs in the US stock market as a whole.
As you can see from the figure above, the US stock market has been showing quite enviable growth throughout its recent history. However, there are a couple of periods (2000 – 2003 and 2007-2009), when it becomes bullish to bearish for some time.
In fact, in graphical representation, a bear market is a usual bearish trend visible on charts with fairly high time frames (from D1 and above). And the reversal of almost any price trend can be predicted using technical analysis tools such as reversal patterns and support / resistance levels.
The difference between a bear vs bull market
Needless to say, the fundamental factor in choosing the direction of trade is trend. Everyone will agree that it is rather difficult to identify an existing trend. It’s because the influence of bears or bulls is sometimes not so obvious. However, if you use technical and fundamental analysis to study the market, you can determine which moods are inherent in the trend at the moment. Beginners should know that it is better to start trading by opening long positions at the moment when an uptrend appears and the price starts to rise. For those who have been familiar with the stock market, the direction of the position does not play a decisive role. The main thing is (especially for novice traders) that the order should be placed strictly according to the trend.
Before moving on to how to trade in the bear market, let’s consider both market States to make sure we know who is who.
Logically, Bulls will prevail in this market. In other words, those traders who open trades to buy, therefore, stimulate demand and cause the rate to rise. We can say that this category includes the most optimistic traders who expect positive news about the asset or the economy in general.
Often an uptrend dominates at such times on the stock exchange, but there is no rush to open short positions. First, it is necessary to find out what is the duration of the price increase and the possible prospects for a trend reversal. There may be a bullish market until the game-changing news is published or until the price reaches the maximum possible level and starts moving in the opposite direction.
The bear market can still be called a pessimistic market, as most players focus on lowering the price and placing sell orders. It is a well-known fact that the value of financial instruments, especially currency pairs, is declining due to pressure from negative news and a continuous increase in the number of sales orders.
Periodically, investing in bear markets increases the chances of closing more positions, the main thing is to capture the right moment when the price reaches its bottom, and you should be very careful not to use the correction for a trend reversal.
To recognize which moods reign in the market at the moment, it will be enough to observe the feeding of recent events and then evaluate the current price movement.
A trader should consider the fact that a downtrend cannot last forever. One day will be replaced by an uptrend, and the market will be taken over by the Bulls. It is crucial to determine the duration of the downtrend before opening a short position. One of the most common bear market trading strategies is to close buy orders, which are more or less at risk.
No matter what market you trade in, you must first pay attention to trading system signals and fundamental and technical analysis data.
What to invest in a bear market
Once you decide to start trading in a bear market, the number one thing you should do is take a deep breath and not jump with both feet buying discount stocks. And it’s not just about investing in the bear market. The same rules apply to every business decision you make. It can be placing an order or closing the losing position. The point is that during a crisis, investors tend to panic and sell everything they have before the price drops too much, or buy everything that is in liquidation. Think carefully about what you are going to do and what your goal is, moving blindly and hoping for the best is not an option when it comes to trading in the bear market.
As each trader has a different trading approach and risk tolerance, they all act differently when investing in bearish markets. Some would prefer to focus on the rotation of the sector, while others would prefer to focus on safe-haven assets, such as gold or some of the currencies. Let’s look at both, so that you choose which one is best for you and meets your trading strategies in the bear market.
Bear investment market using sector rotation
The basic idea behind this strategy is based on the” inequality ” of the dynamics of the market value of assets. It assumes that, regardless of the conditions in the financial markets, the different assets belonging to the same class will show heterogeneous dynamics. Under this strategy, “inequality” is subject to certain regularities based on which it is possible to predict the movement of asset market quotes with a certain degree of reliability.
Based on these forecasts, the investor regularly reviews the structure of his portfolio to maximize the participation of those assets that are expected to exceed other similar assets.
There are two main options for implementing the rotation strategy:
Inclusion and exclusion of assets from the portfolio at the time of its review (in each rebalancing, the investor gets rid of those assets that have exhausted their potential and include new and more promising assets, that is, in this case, the structure of the portfolio undergoes radical changes);
Change in the specific weights of individual assets (each portfolio rebalancing changes the shares of individual assets: the shares of “promising” assets increase and the shares of “depressed” assets decrease, while the assets as a whole do not undergo fundamental changes).
As practice shows, the most effective asset rotation strategy is one that meets the following conditions at the same time:
included in the investment portfolio are characterized by a high level of liquidity;
have a comparable level of volatility;
assets have a sufficiently long market history.
Theoretically, assets can be rotated based on almost any “price” pattern identified by an investor, but in global practice, three main approaches have been widely known, each of which can be effectively implemented in bearish trading.
Geographical rotation. It implies the” inequality ” of the dynamics of macro-regional or national markets, which are conditioned by the details of the development of the global economy in general. Even in the presence of stable macroeconomic trends, local stock markets will show unbalanced dynamics due to the impact of internal factors: level of public debt, unemployment, demographic structure of the population, etc.
Sectoral rotation. The investor redistributes shares between separate sectors within its investment portfolio. This rotation approach implies that the investor tries to use existing patterns in the” inequality ” of the movement of individual sectors of the economy. For example, consumer-oriented industries respond much more to changes in the average income level of the population compared to those that pay attention to investment demand.
Seasonal rotation. It is noted that in many sectors of the world economy, the distribution of income during the year is uneven. Such “inequality” is caused by specific characteristics, which are peculiar to this or that type of business. For example, strongly pronounced seasonality is typical for tourism, agriculture, the production of soft drinks, ice cream, catering, etc. Regardless of the variant of practical implementation of the rotation strategy, it allows investors to increase the return on investment in the bear market to a controlled level of accepted risks.
Bear market investing in safe haven assets
An asset that can become a safe haven must have at least three properties. First, it must have a negative correlation with other important asset classes over a long period. Second, a safe haven asset must have the highest credit quality and near zero default risk and very low storage and settlement risks.
Third, a secure asset must have a liquid market that will not lose its capacity during the crisis, even if liquidity in other markets disappears.
Gold has a reputation as the best safe haven asset in times of economic crisis and financial turmoil. Despite the fact that in the second half of the twentieth century gold lost most of these functions and interests, and rental income of gold does not bring, the growth of the exchange value of quotations of this precious metal is a long-term trend. Gold copes with inflation protection much better than any fiat money. Much better than the price of the commodity basket, expressed in gold, has not changed in two thousand years in Europe. Indeed, a decade of extremely low inflation in most developed economies has significantly reduced the need to protect against inflation. In countries with negative interest rates on deposits, it is more profitable to keep assets in gold bars than in bank accounts. And the role of gold, as a means to diversify the portfolio, and especially to provide positive returns in the event of a fall in stocks is still very relevant.
Cash is also considered a safe haven asset, but some national currencies are at risk of devaluation. Still, some assets can endure in the most difficult times.
These financial instruments include the Swiss franc, as it shows quite consistently. A viable currency is almost unaffected by crisis factors. The last devaluation occurred in 1936, but after the Great Depression, there were no such situations, and the exchange value of CHF remained almost unchanged.
As for the global crisis of 1973 and 2008, one can see how the stable franc maintains its previous position. It is for this reason that the monetary unit is still considered a reserve and serves to preserve capital.
It should be mentioned that such stability is guaranteed by the banking system. Local institutions serve not only their residents but also many wealthy guests. They have brought the country a huge cash flow and a reputation as a global bank.
Another important factor of influence is the provision of gold reserves for banknotes. In the early 2000s, reserves covered about 40 per cent of all national money. Although the currency is rarely used in International Settlements, its rate is easily predicted even for beginners. To analyze the currency pair, it is enough to examine one country, while the state of the second rarely changes.
The economic situation in Japan is an example for most countries. This country is developing at great speed and is considered attractive for foreign investment.
However, from the point of view of a trader, it does not matter in which market make money. He can make money on the bullish market and, with the same success, make money on the bear market in fall. It can be done with the help of CFDs (contract for difference). Basically, it is an agreement between two parties (seller and buyer) to transfer the difference between the value of an asset at the time of opening a position and its value at the time of closing. So, let’s see how trading in the bear market.
Bear market trading using hedging strategies
One of the options to avoid unexpected fluctuations in market assets is hedging, which has already proven its effectiveness for many years. It can be considered a reliable way to protect your finances. It turns out that the price of the asset is fixed for you at the time of the transaction.
There are several methods of coverage:
Intermarket coverage. Spot trading is “interrupted” by futures or options. Let’s say you bought EUR / USD, it means you need to buy a call option with the same volume. There is nothing complicated in this strategy. By accessing the options market, a trader can buy contracts in the opposite direction, risking only the reward of the option contract. If you have correctly determined the direction of the asset, you can sell the option by losing the reward (a small amount compared to the total amount of the transaction). If you make a mistake, the coverage option will work and prevent you from losing your deposit.
Cross-coverage. Assumes the opening of the opposite order in another currency pair. A pair with a negative correlation to the main instrument is chosen. It requires some experience for a successful closing of the position, as well as double investments.
Lock. Blocking positions assumes that one trade will bring profit and the other loss. Risks are associated with misuse of a trading strategy and potential losses in both directions. But if you manage to master this complex trading instrument, you will be able to make profits from both positions. The main thing here is that the profit from successful orders is more than losses to lose. To use hedging during bear market trading, the first thing you need to do is analyze which assets correlate with each other. If there is an uptrend on the EUR / USD chart and EUR / JPY is also uptrend, and Japanese candlestick combinations are similar, both assets can be used. This example is called one-way currency pair coverage. In this case, we are buying in the EUR/USD pair in terms of the current trend. For insurance purposes, in case the rate invests EUR / JPY, we sell the same volume as the first transaction.
The blocking hedging strategy is based on parallel or mirror rate fluctuations, as a result of which we have the opportunity to compensate for failures. The correct use of the described technique will allow not only to minimize losses but also significantly increase profits.
Short sale bear market
One of the ways to invest in a bear market is short selling with the help of CFDs.
In trading, short positions can be used for speculation or hedging purposes. As a result, traders place short orders to benefit from the possible decline in a particular asset or the market as a whole. Hedgers use this strategy to protect gains or reduce losses in the portfolio
Experienced traders and institutional investors often use short positions in bear market trading strategies for both speculation and hedging. Hedge funds are among the most active users of short positions in stocks or individual sectors to hedge their long positions.
Short selling offers traders the opportunity to benefit from a bear market that invests in assets that are falling in value. Please note that these strategies should only be used by experienced traders and advanced investors due to the risk of large losses.
Traders who believe that “the trend is your friend” are more likely to gain in short positions trading bear market than during a strong bullish market phase. Learning to trade in the bear market, traders can sufficiently grow their capital as N times of the market recession falls quickly and deeply, as in 2008-09. In such periods, bears can make more profit.
Are we in a bullish or bear market in 2020?
February and March 2020 are the worst months for global stock markets since 2008. Exchange rates have lost tens of percent, and experts say the 11-year growth cycle since the last financial crisis has come to an end.
In the context of a new outbreak of disease, investors have reconsidered their views on the future of the world economy. Restrictive measures introduced in different countries affected almost all industries related to consumer activity: tourism, commerce, catering, entertainment and others. In quarantine conditions, people spend and move less.
Thursday, march 12, the New York Stock exchange experienced the collapse bigger, since the “black Monday” 1987, despite the decision of the Federal Reserve, acting as the Central Bank of the united States, allocating $ 1.5 billion as short-term loans to stimulate the national economy and stabilize the financial system.
Are we in a bullish or bear market in 2020?
Thus, the US Dow Jones industrial Index lost 9.99% at some trading point, having fallen 2352.60 points to 21,200.62. The S&P 500 stock index, which includes the 500 largest companies in the U.S. market and is called the “barometer of the U.S. economy,” collapsed 9.51 percent (260.74 points) and broke the mark of 2480.64 points. Nasdaq, an index specializing in high-tech stocks, fell 9.43 percent (750.25 points) to 7,201.80.
Are we in a bullish or bear market in 2020?
Currently, we can see optimism in the markets, as the second wave of the pandemic was not so serious, adding to that the anticipation of the vaccine developed by different pharmaceutical companies. Of course, we cannot say right now that the crisis is over, as it will take several years (at least) for the economies to recover.
Paying attention to what we just discussed above, a trader will be able to diversify an investment portfolio in the bear market.