Despite bear markets being a natural period of a market cycle, it may be hard to anticipate such market downturns and equally challenging to adapt your trading strategies to it. There is no universal perfect solution to this problem but there are several general approaches that can be considered.
What is a Bear market?
Bear market in general refers to the condition where prices of assets on the market decline 20% or more down from their previous high levels and are the opposite of bull markets. Investors are likely to see the value of the portfolios fall down and consequently face losses that they need to manage. There can be different reasons for a bear market to occur, such as for example the overall slowing down of an economy, changes in monetary conditions, major sector-specific changes etc, and can likewise last for different time periods. Bear market conditions are often tracked through biggest market indexes such as the S&P500 or Dow Jones that are considered to be market benchmarks.
(NOTE: Before we continue, we have to give a disclaimer that the trading products offered by the companies listed on this website carry a high level of risk and can result in the loss of all your funds. CFDs are complicated instruments that are never guaranteed to provide you supplemental earnings. In fact, Around 67% of all retail investors experienced a loss while trading CFDs. Make sure to keep this in mind before attempting to use the eToro platform yourself. All the information found on this website is not official trading advice and all practices shown are referenced for the use of the Demo account only.)
Trading in Bear Markets
As it may be evident, these are not exactly the best times for investors but can nevertheless present certain great opportunities. It is hard to trade in these market conditions but there are some strategies available that may help limit the damage to your holdings.
Bear market is one of the most challenging market conditions to keep your emotions in place and yet it is vital to be able to separate emotions such as fear or greed from investment decisions. One of the great challenges of trading related to trading in a bear market is the anticipation of how low the prices can actually go once they started falling.
Financial markets are extremely volatile and what may appear to be a worldwide crisis at the time may simply be a temporary dip over a few days. In fact, one of the approaches to coping with a bear market it to ‘play dead’ and simply not do anything, avoiding sudden miscalculated trades and staying calm. In financial markets this often means turning a part of your portfolio holdings into highly liquid assets with short maturities, such as the money market securities; many investors choose to simply hold cash during bear markets. On the other hand, waiting for too long may lead to a missed opportunities once prices start to recover again. It is quite difficult to identify best timing techniques and manage positions in a bear market but can provide great opportunities with a correct approach.
Diversification avoids the problem of ‘putting all eggs in one basket’. Spreading a part of your portfolio over different asset classes can help to reduce the risk associated with one of them losing value. For instance, if the stock market is facing a major downturn while the commodities are doing relatively well, losses from equity holdings could possibly be at least partly compensated with the gains from commodities (that is of course, just an example of how diversification operates). eToro offers many different assets, not only shares of different companies but also instruments from different classes such as indices, commodities, ETFs and so on.
The way you diversify your portfolio depends on your degree of risk aversion, investment horizon, objectives and so on and there are several portfolio composition strategies that can help increase the level of diversification.
Focusing on assets that appreciate in bear markets
This approach involves targeting non-cyclical (also known as defensive) stocks that do well in downturns. Often such stocks deliver a stable dividend yield as well as consistent earnings independently of the market state. For example, stocks of companies that produce essential products, like the food or personal care industries (and other non-durable goods), sometimes perform better relative to the overall falling market. The reason lies in the fact that people continue to use these products no matter the market state and therefore the value of the company and its stock price should not be affected as badly.
Short selling is one of the ways in which one could potentially make a profit in bear markets but it is a very dangerous approach that involves risks and requires a good understanding of financial markets’ operation. Short selling involves selling a share or an ETF that is borrowed from a broker with the hope of it falling down in value further so you can buy it back at a lower price in the near future. eToro allows to open short positions on a variety of asset classes using CFDs as well as use different levels of leverage, like shown on the image below. (Please note that CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 67% of retail investor accounts lose money when trading CFDs with this provider You should consider whether you understand how CFDs work, and whether you can afford to take the high risk of losing your money.)
Short selling involves trading on a margin which can amplify your gains but can equally easily lead to losses in case market start rising again. Luckily, eToro offers several risk management tools such as the basic stop-loss level to assist in trade management. Short selling will only work out well when the market moves down as you anticipated and your assets end up trading at an even lower value. For example, if you short a share at $100 and the stock goes down to $80, you can purchase them at this cheaper price to close off the short position; the difference between these prices is then settles between you and eToro. Beware also of the fees associated with CFD trading, such as the overnight fee charges if you keep you position open for the next day, and of the possible margin calls to your account.
Inverse ETFs, also known as short ETFs take the opposite trades of a particular index it replicated, for example takes short position when the index goes long. This then produces opposite returns to the index; for example, if the index goes up in value then an inverse ETF depreciates and when the index falls such an ETF appreciates. This kind of an inverse relationship can possibly provide an opportunity for investors who want to benefit from bear markets or even hedge long positions in market downturns.
Taking advantage of Dollar cost averaging
If you are a long-term investor, a bear market can even present you with several opportunities, in particular if you adapt dollar-cost averaging as your investment technique. Remember that dollar-cost averaging involves an investor dedicating a set amount of cash to purchase stocks at regular time periods. When the market is in a downturn, a dollar cost averaging investor will end up buying more shares at a lower price for that specific amount of money and that means that over the long term the price of this equity is lower on average.
In fact bear market can provide opportunities not only for investors that adopt dollar-cost averaging as a strategy. Warren Buffet once said that often markets in a downturn can present purchase opportunities since prices of stocks of ‘good’ companies that are otherwise valued more highly go down with the rest of the market. The idea behind this approach is that these stocks will then rise back to their actual value after the overall market begins to recover again.
Perhaps the final step in operating in bear markets is to remember to invest only as much as you can afford to lose. You don’t want to see your life savings or mortgage money disappearing because of a market downturn. It is important to only employ the amount of capital you would be prepared to lose as trading and investing always involves capital loss risks. Hopefully this guide gave you some ideas on the possible strategies in a bear market and you can continue to enjoy trading on eToro. Best of luck!
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Please note that CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 67% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work, and whether you can afford to take the high risk of losing your money.
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