Bear market survival guide: Golden rules for trading in troubled markets
By Jenal Mehta
15:44, 16 May 2022
As the market moves further toward bearish sentiment, capital.com explores how investors can make the most of such a market.
The short term nature of bearish markets gives an advantage for active traders; however, there are plenty of other opportunities to exploit.
1. Correctly identify a bear market
The measurement of a bear or a bull market is measured through its peak to trough.
As a consensus, a bear market occurs when the market drops by at least 20% from its most recent high. Anything less than that is considered a correction.
What is your sentiment on US500?
S&P 500 (US500) Price Chart
What happens when only some stocks fall into a bear market while others don’t? For example, since its latest peak at the end of March 2022, Nasdaq Composite dropped by almost 20%, giving bearish signals. However, the S&P 500 (US500) dropped only 13% from its latest peak, Dow Jones (US30) fell by 9% and FTSE 100 (UK100) fell and then recovered almost fully.
David Jones, analyst at Capital.com says, if only some of the broader markets are falling close to 20%, this should be a strong enough signal for investors.
He says “Personally, I would apply it to stock market indices likes the S&P and Nasdaq – if the broader market has suffered a big decline then it is something that would concern investors, regardless if some sectors are suffering more than others.”
2. Once a bear market is identified, wait!
Coming to the conclusion that a bear market exists is subjective and an overall context of the broader market matters. Investors need to wait before they change their strategy to overly defensive. There are multiple factors to consider in each bear market, and this time is no different.
In an analyst note seen by capital.com, Virtus Investment Partners write about the contradicting signals we are currently seeing in the market. “Bear markets do not send advance warnings. It usually takes a surprise event to push markets into correction territory – such as the failure of Lehman Brothers which spurred the GFC [global financial crisis]. We might have thought that the war in the Ukraine and its aftermath (for example, the spike in commodity prices) would be enough of a shock. The reality, however, is that consumers in the US continue to spend, the housing market is tight, and corporates are delivering on earnings expectations.
However they do warn there are some signs the market is begging to struggle: “We are starting to see some companies begin to lower guidance in the low-quality segment of the market. Companies with no pricing power are struggling to offset the spike in raw material costs and the disruptions to supply chains.”
But what if waiting makes you miss out on a bear market? Jones says: “It is always tempting to try and pick the bottom when you are out of the market. Don’t worry about this! You do not need to pick the bottom of the bear market to profit from the subsequent bull market – there is normally plenty of time to get back in on an upwards trend.”
FTSE 100 (UK100) Price Chart
3. Unique opportunities
Beyond the absolute rule of 20%, there are other trends investors could exploit within a declining market. Two notable trends pointed out by Fisher Investments are:
- One third/two thirds rule: In their research, Fisher Investments found that during bear markets, one third of the value lost occurs during the initial two thirds of the bear market period. Two thirds of the value lost is during the last third of the time period. Simply put, during the end of a bear market, a sharper decline occurs.
- 2% rule: in a bear market, the decline occurs at approximately 2% per month, which means the bear markets do not start with a sharp sudden drop, but rather as a slow steady decline. If a drop of more than 2% is occurring, the market maybe under correction rather than in a bearish sentiment.
4. Bear markets are short term
When duration is compared between both bear an bull markets, historically bear markets have sustained themselves for a much shorter period.
Raymond and James outlined the performance of the S&P 500 since 1926, revealing that while a bull market lasted on average 8.9 years, a bear market only existed for 1.4 years on average.
For investors to make the most of a bear market strategy they would have to think short term for their declining market strategies.
5. Plan for recovery, not just the dip
A new bull market begins once the market gains at least 20%. Bear markets are probably best seen as a time to plan ahead and to make the most of the upcoming recovery.
Jones says: “If you are a long-term investor then bear markets just give you an opportunity to buy in cheaper – particularly if you are paying into some sort of investment vehicle on a monthly basis. Bear markets give you a lower cost average in the end and, as we have seen historically, markets do recover.”
Markets in this article
