What’s an investor supposed to do when a bear market wipes away years worth of gains? Considering it happened between 2000 and 2002 and then again in 2008, it’s a question with asking. Here are a few ideas investors can keep in mind to not only avoid losing money in a bear market, but actually make money from it.
Some of these tactics are more advanced than others, such as the use of options, or employing inverse leveraged ETFs. Don’t be intimidated by any of them. Investors of all skill levels can learn and apply these ideas.
First and foremost, use stop losses. It goes without saying, right? Yet, most investors simply don’t apply this most basic defense against a falling market. Never let a small loser turn into a big loser.
Of course, there’s no set amount of how much of a loss is “too much”. For long-term stock investors, a retreat of 8% from any peak may be a good exit point. For short-term scalp traders who aren’t even looking for an 8% gain on a trade, stop-losses of 1/3 of the targeted gain are reasonable. For option traders, a 30% berth may be required. It’s all relative.
The second prudent bear-market strategy is the use of so-called ‘inverse’ ETFs (exchange-traded funds). What’s that? Just like the name implies, and inverse ETF moves in the opposite direction of its underlying index. In other words, they go up when the market goes down.
To maximize the use of inverse ETFs, leveraged inverse ETFs create percentage gains that can be twice as much as (if not three times as much as) the loss of its underlying sector or index. In other words, a 5% selloff in the market could translate into a 10% or even a 15% gain for a leveraged inverse exchange-traded fund.
One note about inverse exchange-traded funds…. they obviously aren’t tools you’d want to use for long periods of time, since the leverage works against as much as it does for you. As with most hedges, their best use is usually situation-specific.
Your third option specifically requires a margin account, though opening one can be worth the effort. Simply put, you don’t have to buy low and sell high to generate a profit. You can also sell high. And then buy that stock back later at (hopefully) a lower price.
But aren’t short sales and margin accounts specifically reserved for savvy speculators? Not really. Considering the stock market literally retraced 100% of its gains not once but twice between 1999 and 2009, a ‘buy and hold’ strategy just isn’t going to get the job done. Investors actually need short sales and margin accounts if they intend consistently ramp up their portfolio’s value.
The last money-making opportunity that bear markets present are the gains to be had by owning put options on falling stocks or falling indices. Like ETFs, they can gain in value at a rate faster than the pace at which the market falls. The added attraction of put options is choice – a wide variety of strike prices and expirations means a trader can take on whatever degree of risk and reward he or she would like to.
On the flipside, options eventually expire, while stocks and ETFs don’t. The trade-off is simply that options can cost a fraction of what it would cost to take on an equivalent position in a stock or ETF, essentially making option trades a ‘disposable’ hedge.
With all that being said, there’s one more strategy to understand…. or perhaps it’s just more of a reality to recognize. Though it seems as if a bear market drives every stock, every sector, and every market cap lower, there are always a few stocks going higher. You just have to work harder to find them
The ultimate message should be simple… it doesn’t take a genius to survive a bear market – it just takes a little action, and some willingness to learn how to do a few new things. Don’t let another downturn push your portfolio in the wrong direction.
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