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What Should You Do When Bear Market Starts?

A smart investor understands the different stages of the economy to guide his investment decisions. So what should you do when the bears come?
Author: Jack Wickens
Jack Wickens

Writer, Contributor

Experience

Jack is a personal finance writer who has been writing for more than a decade. His passion for educating consumers and helping everyday families earn more and live better. He is most knowledgeable with years of experience covering topics such as savings, budgeting, and responsible credit use and always happy to share his expertise with readers.

Review & Fact Check: Baruch Mann (Silvermann)

Baruch Mann (Silvermann)

Financial Expert, The Smart Investor CEO

Experience

Baruch Mann (Silvermann) is a financial expert and founder of The Smart Investor. Above all, he is passionate about teaching people how to manage their money and helping millions on their journey to a better financial future.
Author: Jack Wickens
Jack Wickens

Writer, Contributor

Experience

Jack is a personal finance writer who has been writing for more than a decade. His passion for educating consumers and helping everyday families earn more and live better. He is most knowledgeable with years of experience covering topics such as savings, budgeting, and responsible credit use and always happy to share his expertise with readers.

Review & Fact Check: Baruch Mann (Silvermann)

Baruch Mann (Silvermann)

Financial Expert, The Smart Investor CEO

Experience

Baruch Mann (Silvermann) is a financial expert and founder of The Smart Investor. Above all, he is passionate about teaching people how to manage their money and helping millions on their journey to a better financial future.

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Table Of Content

It seems like the bear market close. Very close.

History proves that the stock market and the economy move in continuous cycles repeatedly.  A smart investor understands the different stages of the economy to guide his investment decisions. The stock market also has its own unique definitions that are popularly called the bull and the bear market.  Both of them have their own set of overtones.

A bull market is a situation in the financial market where prices of stocks are rising or are expected to rise.  This is a period when investors show huge confidence.  Strictly, a bull market happens when the rise is at least 20% as when Nasdaq climbed during the tech boom. Popularly, most investors have a much looser condition to consider it a bull market.

What Exactly is a Bear Market?

A bear market is quite the opposite.  It is a condition in which security prices fall and widespread pessimism fuels the market downward.  Investors normally anticipate losses and most are forced to sell-off.

While bull markets are driven by optimism, bear markets, which occur when stock prices fall by 20% or more for an extended period of time, are the polar opposite. Bull markets are typically fueled by economic strength, whereas bear markets frequently occur during times of economic slowdown and higher unemployment. Rather than wanting to enter the market, investors prefer to exit, often seeking the safety of cash or fixed-income securities. As a result, it is a seller's market.

Bear markets can last anywhere between a few weeks and several years. The Great Depression was the first and most well-known bear market. Other examples include the 2000 dot-com bubble and the 2007–2008 housing crisis.

What Effect Has A Bear Market On My Investments?

A bear market will cause a drop in prices of the securities you already have, sometimes to a sizeable degree. The decline may be extended over a period of time or it may be abrupt.  However it decreases, the end result will be obvious – the stated value of your holdings will be lower.

Two basic principles will now come into play:

  • A bear market works against you if you plan to sell your stocks or if you need money urgently;
  • Falling stock prices and depressed markets work in favor of the long-term, value investor.

In other words, if your intention were to hold your investments for years, it would be great to buy during a bear market.  I am aghast at experts who advocate selling after the stocks have lost their value.  The best time to sell in this situation was before the prices began going down.  A true expert would have warned investors that the crash was about to happen before it actually did.

How Long Does a Bear Market Last?

The analysis of the S&P 500 index between 1929 – 2020 shows, on average, a bear market lasts for 9.6 months. The data was drawn from the 26 incidents lasting from a high of 630 days to a low of 33 days, averaging 298 days.

On further examination, it means you will expect a bull market, on average, to occur every 3.6 years. In addition, the report shows a bear market does not indicate a recession. Sometimes, it might be a slowing economy. For instance, of the 26 incidents, only 15 occurred during a recession period.

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Should You Buy in a Bear Market? 

During a bear market, there can be an opportunity to buy stocks. However, you should be aware of the cliché, ‘never go against the trend.’ Your moves will be highly speculative and risky. But it does not imply there are no opportunities in this market.

To start, you have to understand the trendline, interpreting resistance and support movements. For example, during support, some investors buy long, and during resistance, some investors go short. The behavior is due to the inherent nature of the stock market. Typically, the stocks do not behave linearly. They are cyclical. Therefore, you can seize the buying opportunity when an opportunity presents itself. A different approach is to time for market reversal after the bear is exhausted. During the uptrend, you can buy your stocks.

Fundamentally, if you have a diversified basket of equities, reinvesting your dividends speeds up your returns.  It acts as a ‘total return accelerator’ and ‘bear protector’ – two descriptions coined by Wharton Professor Jeremy Siegel.  Doing this drags down the cost basis of your portfolio as a whole.  In order to reach the original cost of the investment, the quoted market value needs to increase gradually.

Let’s look at the Great Depression as an example.  If you take the stock prices as a whole, it might appear that it took 25 years to recover.  However, for an investor who held his shares, reinvested his dividends and then sat tight, results came shortly. In such case, breakeven could have happened in a few short years.

Where Investors Put Their Money in a Bear Market 

During bear markets, you can employer various strategies to protect your investments. Here are some of the strategies you can use:

  • Buying short and long-term. Since it is a downtrend, investors borrow stocks from brokers to sell them at current high prices and later buy them at lower prices to profit from the difference.
  • Leveraging dollar-cost-averaging. Here investors bet on a rebound. They buy cheap stocks at an interval of $1000 per purchase every month and hold them. A great example is the events lasting from 2007-2009. Investors who had put their money in 401k plans raked in good returns.

Do And Don't Do When Bear Market Starts

A bear market appears dreadful to many investors.  Many naturally expect that they would lose money.  However, it also creates many opportunities.  We suggest that you don’t run away from a bear market and remember the following:

Stay Calm And Avoid Panic Selling

During a bear market, many investment ‘prophets of doom’ will emerge. They will predict a stock market doomsday or a ‘financial Armageddon’.  Some will wildly advise for you to “sell everything now.”

The last thing you want to do is panic.

As in anything, panicking causes you to make ill-advised moves that could lead to catastrophic consequences.  Financial markets have no pity to those who sell early or late.  Take note that bear market losses are only ‘on paper’ unless you do actually sell. 

Use your head and not your heart.  Do not sell out of fear.  In fact, to survive a real grizzly bear attack, one is supposed to play dead and lie very still.  Running away or fighting back can be very dangerous if not outright fatal.

Stay Level Headed

Keep your emotions in check at all times.  Do not be jittery whenever stocks sell off.  Fear is your worst enemy when the bear appears while greed is your most ferocious foe in a bull market.

Think back why you invested in stocks in the first place.  If you just wanted to make a quick buck, you have most probably chosen the wrong investment channel.  If you are set on a five, ten or twenty-year term, you are okay.  You know fully well that stocks go up over time and it would be senseless to rush it.

You may also encounter a flash sale on the market. Remember that a flash sale is just a sale and there’s nothing complicated about it.  If you were buying a year ago, all you need to ask is: what has fundamentally changed about the companies in your portfolio? 

If the only real change is that their prices are down, then there’s no real basis not to buy more of those stocks.  Anyway, you paid more for these same stocks twelve months before.

Make An Accounting Of Your Situation

Review your overall financial situation before making any move in or out of the market.  Make certain that your money and financial standing are as stable as possible.  See to it that you have an emergency fund of anywhere from three to six months of monthly living expenses.

Manage your debts and keep them reasonably low.  Review everything that directly impacts your finances:  your work, business, insurance, mortgages, etc.  Go through a financial check-up with your financial adviser.

Forget Being A Midas

I know people will give me flak because of this, but if you think you are a gold bug, wake up.  If gold is your protection of choice, you better rethink your strategy.

Yes, for a long time, gold has been a reliable hedge against equities. Unfortunately, it has been losing its status as the go-to sanctuary for investors when stocks start plummeting.

Let me just clear this up.  I’m not saying you should not allocate some of your portfolio to gold or gold extractors – you should, actually and we have already summarized the best ways to invest in gold.  But if you’re depending on them as a hedge against securities, you might end up disappointed.  If you really want to hedge, check out the next point.

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Hedge Intelligently

The best way to protect yourself against falling stock prices is by directly hedging your positions.  I’m not talking about buying an ETF that tracks the inverse of the S&P 500.  I’m saying use option contracts for their real purpose.

Although they may sound intimidating at first, options are relatively simple.  Options are also investment vehicles and investors should take advantage of them.  They grant the right to buy or sell specific shares at a set price on or before a certain date.  The good thing is, there is no obligation to buy or sell.  The right to buy is called a call option while the right to sell is a put option.

How To Hedge Smartly?

Obviously, you can hedge your position using any of the 3 options: buying puts, selling calls or by short sell a specific stock or index.

When you buy a put contract, you purchase the right to sell a specified number of shares at a set price. For instance, you have 100 shares of MSFT purchased at $75 apiece.  Purchasing a block of 100 put contracts at a $65 strike price will limit your losses for the duration of the contract. In this case, you can still sell your shares at $65 apiece even if the stock is trading for $50.  You will effectively cap your losses to only 13% plus the cost of the contract, of course.

If you sell a call contract, you sell someone the right to buy shares from you at a set price.  Here, selling translates to the possibility of immediate income.

Sticking with the scenario above, you can hedge your position by selling a call contract.  You can sell a block of 100 shares at a $90/share strike price. This way, you cap your gains to 20% but in a bear market, this will be worthless and expire.  However, when your stocks fall in price, you can still get paid.

Ask Experts

When falling markets become overwhelming, it’s time to give your Financial Advisor a call.  Your Advisor can put things into a reasonable perspective. I will say that most of these experts have “been there, done that” many times before.

Since during these times you can be emotional, I will advise you to talk to more than one expert, and even considering to use Robo advisors that neutralize any human feelings (but not sure they would be able to deal with extreme cases).  They will expectedly have a better understanding of how to deal with bears than the amateurs.

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Quit Watching In Charts

Checking your trading account and watching stock charts on an hourly basis is a bad habit.  Although it is good practice to keep abreast of the developments in the companies that you own, be reasonable.  Frantically checking your balance moment-by-moment will likely confuse you more.

We all want to log in and see our bottom lines rise every day but in reality, it takes time.  Panic watching does nothing to influence your holdings and does everything to play with your emotions.

In a bear market, it is torture to obsess about your balance.  It’s the kind of behavior that magnifies the situation and leads to wrong decisions.  When you keep seeing red, it could be enough for you to just sell even when you shouldn’t.

At times, the best thing to do is a pause.  Take a breath of outside fresh air.  Enjoy your day. Smell the flowers.  Believe that the storm will pass (it always does) and then the sun will shine again.

Remember: Cash Is The King

When the bear is approaching and behind it are the dark economic clouds, look at your cash assets.  Keep them in safe, interest-bearing instruments such as bank investments, US Treasury Bills and money market funds.  Do this to safeguard your money and also earn a good return.  When stocks are falling by 10, 20 percent or more, you’re more likely to come out ahead with these vehicles.

Many ‘would be’ investors take the words of Warren Buffet, Howard Marks and the like, out of context.  They think that investing in a bear market is as simple as aggressively buying cheap stocks.  Going long in everything and anything that screens low is not the way to do it

To believe that a bear market makes investments cheap is to believe in a myth.  What a bear market actually does is to make investments mispriced.

 

Choose Distinctively

Let me put it this way:

In many instances, a bear market causes some good stocks to go really down.  In fact, some of the best opportunities arise from stocks that the market has unwittingly viewed negatively.  However, it is hard to identify these opportunities for the reason that it also goes the other way.  There are also many mispriced stocks whose prices have gone up due to market (mis) perception.

Nevertheless, the market is generally intelligent. For the vast majority of stocks that fell 90%, there is indeed a valid reason why they fell.  A lot of these stocks are in reality, worth nothing.

As an investor, your job is pretty straightforward:  to distinguish between mispriced stocks.

A stock that fell 90% still has the probability of falling yet another 90%, and so on.  I like it because irrationality abounds in a bear market and the entire market becomes inefficient.  In a normal condition, I consider myself lucky if I find 1 or 2 compelling options in a year.  In a bear market, these distortions become more bountiful.

FAQs

When a bear market is approaching, the market experiences prolonged price declines, and security prices may fall 20% or more over a sustained period, often two months or more.

A bear market can also be characterized by an overall decline in indexes like the S&P 500, with the weekly charts showing lower lows and lower highs. Other signs that the bear market is coming include rising interest rates, falling industrial production, and tightening market conditions.

The decision to retire during a bear market rests with you as an investor, and you should understand the consequences of your actions and plan accordingly.  

On average, you should expect a bear market to last for 9.6 months. The longest bear market between 1929 and 2020 went for 630 days, approximately 20 months. Therefore, during this period, you must have a plan to see you through. That means setting aside some money to offset your expenses. You also need to ensure you have some other sources of income to substitute your stock returns.  

The idea that bear markets cause recession is not always 100% correct. A bear market trend may as well mean something entirely different is happening in the stock market.

For example, between 1929 – 2020, there was an observation of 26 bear market trends. Of the 26, only 15 occurred during the recessions period. The rest 11 are not recession-related. However, wherever recession roams, you can expect a bear market. 

The sloping or the downward trend of a stock trend closely resembles a bear attacking its prey by swiping down its paws, hence the name bear market. In this case, the market prices are sloping down the hill, indicating the stock is losing value.

During this period, the opening price is higher compared to the closing price. When the trend persists for a prolonged period with a recognizable pattern, it becomes a bear market.