A Bear Barket presents a great opportunity for an investor to make money during a recession.
According to the definition, a Bear Market emerges when there is at least a 20% depreciation from the height of the equity prices.
Often this period is denoted by depressed income (possibly a big loss of money), but there are actually ways to insure yourself against the market drop, and potentially make you big bucks in the downturn.
What will I learn?
Acknowledge that it’s a Bear Market After All
Regardless of your reluctance to accept that the Bull Market is over, a fact is a fact (please see definition above on Bear Market).
The changing market condition could best be captured on technical charts, which demonstrate new patterns such as lower lows and lower highs.
The previously defined support level will be trashed and to be replaced by new lows. Such patterns would exert themselves in the coming days or weeks if the market never gets to break through.
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Sell Stock Short
This technique involves getting some stocks on loan from your stockbrokers so that you can sell them to potential buyers.
This can work really well if you anticipate the price is set to go down even further.
Once you are satisfied with the level of the decline, purchase the corresponding stocks from the open market so that you can square your position.
In a Bear Market, it is natural to assume that most businesses would come down in their share prices. My advice is to go for those stocks that you think will display the steepest drop.
Just for the sake of illustration, you may think that the stock of some tech company is truly overpriced especially when it has yet to make any positive profit. This is the kind of stock I would pick to short in a Bear Market.
Buy Put Options
Put option can make you money when the corresponding stock declines in value. Just the same, you stand to lose money when its stock appreciates in value.
If you think that the overall trend is bearish in nature, it might be wise to put options on major indexes such as the NASDAQ or S&P.
The strategy is an excellent one to mitigate your risk, as you will be betting against the overall market rather than just one particular stock.
Purchase Bear Market Funds like Those Offered by Rydex
The Bear Market funds make clever use of the derivatives to facilitate the creation of positions on the NASDAQ or S&P.
Similar to the Put Options, the fund value goes up when the market is down.
Certain “innovative” funds adopt highly leveraged positions in order to double up the inverse return of the index. That is to say, if the index suffers a drop of 1%, the appreciation of the fund value goes up by 2%.
Recognize When the Bear Market is Coming to an End
No market will go into perpetual fall.
It is safe to assume that when stocks were hammered down to some predetermined level, there were bound to be investors who would start contemplating getting back into the market and picking up those undervalued stocks.
As a general guideline, a Bear Market is considered to have hit its rock bottom when the mood among investors and the general public is the bleakest.
The prevailing mood is most likely associated with the popular belief that when the price keeps dropping, it will continue to drop.
The Bottom Line
You will need to be careful when you do adopt these short tactics during a Bear Market, as they tend to suck up a fair bit of cash especially if you have a tendency to accumulate a number of positions over a short duration of time.
But sitting on the fence and tweaking your fingers will not do you any good either.
Take some calculated risk, and let your earnings roll during a Bear Market.
When the market changes direction, you will be sitting on a cash pile and in the best position possible to profit from the next Bull Market.