In a bear market you should trade very carefully. This is no time for cutting corners. Have a clearly defined trade plan for each stock and stick to it. The use of limit orders is an absolute must. The release of major economic numbers should be considered in the timing of your trades. Wait for the major sell offs before entering a trade to allow the natural flow of the market work for you rather than against you.
Table of Contents
- Introduction
- Fear vs. Greed
- What is a Bear Market?
- Understanding a bear market
- Dangers of trading a bear market
- Advantages of trading a bear market
- Why Swing Trading is the best type of trading for Bear Markets
- Bear Market Trading Rules
- How to Know the market and the financial and socio-political forces at work
- Key Takeaways
- Conclusion
Introduction
The term “Bear Market” brings more fear and angst to investors than any other term. One of the reasons investors fear Bear Markets so much is because there are so few of them. (Only 10 since 1950 according to Motley Fool) Since Bear markets are infrequent, investors and traders are not familiar with market movements driven by fear rather than greed. This article is designed to bring you more insight so you can better navigate the Bear Market while you trade.
Fear vs. Greed
No discussion of a bear market would be complete without talking about Fear and Greed. They are the two primary emotions that rule the market. When you look at a stock chart you are really looking at a visual representation of the reactions of the market participants driven by the emotions of fear and greed. When the chart line rises, it represents greed. When the stock’s chart line goes down it is a visual representation of the emotion of fear in that stock or stock average. As you trade you must always respect which emotion is ruling the market at the current time.
What is a Bear Market?
A bear market is usually defined as any market or stock that has declined in price 20% or greater from its recent high price. While this may be the technical definition, there are a lot more characteristics of this type of market. A bear market is a market where fear rules. In a bear market, get ready for sharp, quick downturns as investors are hyper reactive to any potential negative news. Many times, news that may at first seem good for a stock, can become bad news for seemingly no apparent reason. The general direction of prices is down. Charts of the major averages (Dow Jones etc.) are making lower highs and lower lows. Just when everything looks bleak, a major rally comes along and tricks investors into believing that the bear market is over. Then out of nowhere the bottom drops out again and the market will test recent lows. This is called a bear trap and it usually ends with a further large drop to new bear market lows. Many experts say the only way a bear market ends is with a crescendo panic selling event.
Understanding a bear market
A bear market is merely a market that is experiencing more fear than greed. The market at these times tends to have the following characteristics
- “Smart money” meaning professional traders and hedge funds are swimming in the same waters as you. If you think you are going to outsmart them, you are wrong. The way to win in this type of market is to make sure you are on the same side as the smart money.
- Bear Markets usually coincide with economic downturn like a recession or depression
- In Bear Market, stocks and the market averages tend to open “strong” and close “weak”.
- Bear Markets many times occur following rate hikes by the Fed
- Lower highs and lower lows on most stock charts
- More stocks going down than up (Advance/Decline)
- Some “defensive stocks” and sectors can do well
Dangers of trading a bear market
- High Volatility
- Constant Flow of unexpected bad news
- Stocks dropping very large percentages
- Stocks dropping unexpectedly or seemingly no reason
- Companies missing earnings and/or revenues
- Companies issuing revised “guidance”
- Companies cutting dividends
- Market liquidity issues
Advantages of trading a bear market
- Higher volatility creates some major opportunities
- Purchase quality at major discounts
- Market encourages stock splits
- Bear market rallies can be powerful
- If you get in trouble time could be on your side
Why Swing Trading is the best type of trading for Bear Markets?
When it comes to trading styles best suited for the bear market, hands down Swing Trading is the best. Long term trading in this market can result in you purchasing too much stock at what later becomes too high a price. Day traders can be crushed by news events and economic occurrences. Swing trading takes advantage of shorter-term movements, but still gives you enough time to make necessary corrections to get winning trades.
Bear Market Trading Rules
- Small traders should never even think of attempting to short the market
- When a rally does occur, don’t be fooled thinking the bear is over. Bear markets contain may “traps” and “head fakes” that usually destroy individual traders.
- Position size is critical: stay small and build positions
- Stick to trading higher capitalization stocks that show great quality
- Watch the market averages (all ships ride the tide)
- Watch for repetition of stock chart patterns across many types of stocks
- Always use limit orders: unless it is an absolute emergency, professional traders use limit orders exclusively
- Get in rhythm with the market
- Determine your trade goals when the market is closed, and you can have a clear mind to think
How to Know the market and the financial and socio-political forces at work
- Pay attention to the US Economic calendar every day (try MarketWatch: marketwatch.com/economy-politics/calendar
- Watch the financial news (Selectively)
- Understand how much the movement of the general market indexes effects your stock
- Identify and track any other market indicators that are currently affecting the market.
Key Takeaways
- Bear markets are dangerous, be careful
- Do not assume anything/do your homework
- Stick to your disciplines
- Make solid plans and stick to them
- Use limit orders like the professionals
Conclusion
While a bear market is never good for investors, it doesn’t have to be a disaster. If traded correctly, it can become a time of amazing opportunities. One thing is for sure, there is added risk in this type of market, and you must make sure you are extremely careful. So, if you are in a bear market, put yourself in a position to win by implementing some of the ideas discussed above.