A Smart 7 Point Checklist to Consult Before You Invest In a Bear Market

By Chika

-

Last Updated: November 18, 2021

Share

786
0

The stock market has been in its longest bull run in history.

Since 2009, the S&P 500 has rallied by over 400%. Even the pandemic-induced economic shutdown could not slow down the market's upward momentum. In such an environment, it is easy for investors to get complacent and be lured into thinking that stocks only go up.  

Experienced investors know that the market moves in cycles, and as such, it is logical to expect a drawback after a long bullish streak.

With the stock market indexes constantly setting new all-time highs, it may be time to take a step back and begin to plan for a bear market. Though it is almost impossible to say when this would happen, it's always better to be prepared for the day it comes. 

 

2 Ways to Spot Bear Markets

Markets trade in cycles, which means most investors will experience both bull and bear markets.

The key to profiting in a bear market is knowing how to spot when the markets are starting to top out. Bear markets usually happen when the broader index has declined by 20% from its recent highs. However, before it gets to this stage, the market would have been showing some signs. 

1. The Advance/Decline Line

One way to spot a bear market is by looking at the advance/decline line.

This technical tool represents the number of advancing issues divided by the number of declining issues over a given period. A number greater than 1 is considered bullish, while a number less than 1 is considered bearish.

A declining line during a period when markets are rising could signal a correction. When the line has been declining for several months while the averages continue to move higher, this could be considered a negative correlation, and a major correction or a bear market is likely. 

2. The Federal Reserve Raises Interest Rates & Tightens Up on Credit

Other signs which investors can use to anticipate a bear market are the Federal Reserve raising interest rates and tightening credit.

When the central bank raises interest rates, it is risk-off, as stocks look less attractive. As a result, investors would invest in relatively safer instruments such as bonds. The reduction of trading volume drops and subsequently stock prices. 

The market operates in cycles. As such, before a significant drop, the market would have reached all-time highs.

According to analysts from Bank of America, the stock market has returned at an average of 30% in the last 24 months of its bull market. With the market continually setting new record highs, it may be an indication that the bull cycle may be coming to an end. 

Looking for more info on investing? Read this next: Inflation: Should You Stick With Growth Stocks?

 

7 Ways to Invest in a Bear Market

1. Keep your emotions in check

Emotions are the most important attribute of investing.

Inability to wield control over your emotions can lead to substantial losses, regardless of capital. The best investors are those not easily swayed by the emotions in the market.

In a bear cycle, it's easy to get caught up in the prevailing fear in the market. However, history has shown that the market would also rise. As such, a bear market is not the time to be frantic and take knee-jerk actions that would hurt your portfolio.

Bear in mind that every cycle in the market comes with its opportunities. Keeping your emotions in check and numbing the noise is critical to your success as an investor in a bear market.

 

2. Keep some cash on the sidelines

The only way you can profit from opportunities in a bear market is if you have the firepower to take advantage of them when they show up.

With the market showing no signs of slowing down from its upward trajectory, and inflation biting harder, it can be difficult keeping cash on the sidelines. However, while investing, you also have to spare cash to pounce on any opportunity.

If you don't want your money sitting in a bank, you can invest in less volatile assets like mutual funds or index funds. Alternatively, you can use some good-quality stocks in your portfolio as a store of value for your cash reserves.

This way when prices of stocks begin to fall in a bear market, you would be able to buy them cheaply. 

 

3. Dollar-cost averaging

It is impossible to know when the market would bottom out in a bear market.

So jumping in to buy just because stocks are cheap may be a very bad strategy. A more prudent approach to investing in a bear market is dollar-cost averaging. This is an investment strategy whereby the investor continually invests a total amount in installments over a particular period.

For example, if you have $1000 to invest, rather than invest the lump sum, you can invest that amount in 5 equal installments of $200 each. By investing in installments, DCA minimizes the risk of incurring a substantial loss resulting from investing the entire lump sum. 

 

4. Invest in quality companies

It is always easy to head for the exit door when the market starts to fall.

But you may just be shortchanging yourself from long-term profits. The best time to buy is when everyone is selling, and a bear market aptly suits this bill. You can get stocks of quality companies for a cheap price.

Look for companies with strong fundamentals, strong earnings growth, and low debt. The market would finally come around to these stocks when the pessimism of the bear market fades away. 

 

5. Invest in Inverse ETFs

You can profit from a bear market by investing in inverse ETFs you can profit from the decline in prices of stocks.

These ETFs provide the opposite return of the underlying assets they are tracking. Inverse ETFs and mutual funds are investment vehicles that appreciate as the market declines, making them a good choice for investors in a bear market.

However, some of these ETFs tend to be illiquid, so you have to conduct your due diligence before making a choice. 

 

6. Invest in resilient sectors

Some sectors can brush off the effects of a bear market better than others.

Defensive sectors such as consumer staples, real estate, and utilities perform well in bear markets and weather the effects of drawdown better than others.

Index funds and exchange-traded funds, which track a market benchmark, can be used to invest in certain industries. Investing in an ETF that tracks consumer staples, for example, will provide you with exposure to firms in that sector.

This is a cheaper and less risky way of investing during a bear market. Because each fund holds shares from different companies, this provides greater diversity to the overall portfolio than a single stock.

 

7. Concentrate on the long-term

Bear markets would test your mettle and put your resolve to the test.

While these times are tough to bear, history indicates that the market will most likely rebound quickly. If you're saving for a long-term objective, like retirement, the downturn markets you'll face will be outweighed by bull markets.

Short-term goals, defined as those that must be accomplished in less than five years, should not be invested in the stock market.

Still, resisting the temptation to sell investments when markets plummet is difficult, but it’s one of the best things you can do for your portfolio. 

 

The Bottom Line

Even if some monetary losses are unavoidable, witnessing a bear market does not have to be about pain and loss.

Instead, investors should see what is offered to them as an opportunity to learn more about how markets react to circumstances surrounding a bear market or any other protracted period of low returns.

We may do fairly well by utilizing some alternate tactics during periods when many others are experiencing significant losses in their portfolios.

Photo by Pixabay

YOU MIGHT ALSO LIKE

Leave a Reply

Your email address will not be published. Required fields are marked *

This site is protected by reCAPTCHA and the Google Privacy Policy and Terms of Service apply.

LATEST

Subscribe for daily financial content

Daily articles, financial messages and affirmations to best help you navigate your financial future.