Best Trading Strategy In Bear Market: Global stock markets are experiencing one of the most sustained repricing episodes in recent history.
A massive $8.5 trillion was wiped off the value of the S&P 500 in the first half of 2022, and each bounce is met with a further wave of selling. Moreover, with stocks seemingly in free fall right now, the opportunities for profitable investments appear limited.
But that doesn’t have to be the case. In fact, there are plenty of ways to make gains during a bear market, and, in this article, we’ll examine a few of the most important.
While some of these methods might suit your own portfolio needs more than others, you’ll soon discover that each trading strategy has a unique set of applications and potential benefits to boot.
Source: Unsplash
Play The Long Game
It’s not always necessary to radically alter your trading strategy when the markets go against you.
The fundamentals of investing remain the same, and knee-jerk reactions to sudden price movements can be counter-productive.
Indeed, the old adage to “buy low, sell high” is never out of season, and bear markets offer the perfect opportunity to acquire quality companies at heavily discounted valuations.
In fact, Warren Buffett believes that market downturns help sift the wheat from the chaff, eliminating overleveraged businesses and letting the quality ones shine through.
Although it might be tempting to try and time your entry into the market to catch the absolute bottom, a better strategy would be to take a long view and build your positions slowly over time. Focus on good companies that have competitive advantages and tangible moats – and perhaps look for firms that offer reliable dividends that promise you a cash flow no matter what the rest of the market is doing.
On top of that, you can always follow the Oracle of Omaha’s advice and take the tried and tested route of dollar cost averaging. This entails dividing up your share purchases into predefined time slots, buying whatever stock you’re investing in at whatever price it just happens to be.
The idea behind this method is that, while you could end up overpaying for your shares on some occasions, you will also underpay on others too. This strategy helps to weather depressed market conditions, and prevents poor investment decisions that may be more informed by emotional reactions than cool-headed logic.
Don’t Hold On To Bad Positions
Mark Minervini is a legend in day-trading circles. Not only is he the winner of the United States Investing Championship 2021, but he’s also a passionate educator on all things market-related.
Despite being known for his sophisticated use of technical indicators, Minervini is unusual in that he employs many fundamental tools in his trading exploits too.
In fact, Mark developed a toolbox of five rules he uses to inform all his investment decisions. These include:
- never doubling down on a losing trade,
- never letting downside risk override the upside,
- always taking profits when you have them, and
- not letting big wins run into small losses.
But, by far his most important rule is to always – always – use a stop loss. Indeed, as the great man often reminds us, he’s never gone without one in over three decades of trading.
In over 3 decades, I have never traded without a stop loss on a single trade. pic.twitter.com/kBqYZdhZf9
— Mark Minervini (@markminervini) January 25, 2022
And you don’t just have to take Minervini at his word: Mark recorded an average annual return of 220% in his first ever U.S. Investing Championship, going on to take first prize in 2021 with a huge 335% gain in the $1,000,000+ stock division category.
Limit Your Risk
Stanley Druckenmiller is easily one of the greatest investors of all time. Indeed, not only did the Wall Street wizard never have a losing year, his investments compounded around 30% annually from 1981 until the time he decided to retire.
Interestingly, Druckenmiller’s trading strategy has oftentimes been labeled as somewhat idiosyncratic – especially when viewed in the light of traditional investing wisdom. For instance, Druckenmiller advocates putting “all your eggs in one basket,” which, he says, helps sharpen your investing senses to focus on getting the most out of whatever positions you currently hold.
What’s not in contention, however, is the fact that Druckenmiller gets results. Along with his business partner, George Soros, the Quantum Fund manager took a big bet shorting the British pound in 1992, eventually netting the pair a $1 billion reward.
While there are many qualities that make Druckenmiller a formidable investor, one of the recurring themes of his approach is the ability to minimize needless exposure to risk.
One way this plays out in a bear market is that investors need to avoid relying too heavily on unsafe short positions. Indeed, in a recent interview at the 2022 Sohn Investment Conference, Druckenmiller cautions that “you can get your head ripped off” in a short squeeze scenario, if all the wrong things happen to play out.
Furthermore, Druckenmiller also advises protecting your capital so that you can live to trade another day. Although it seems counter-intuitive, over-diversifying can actually increase your risk profile, and lead to you losing a significant portion of your cash on low-conviction investments.
And Finally: Don’t Forget To Hedge
If you want to actively generate income in a bearish market environment, you could consider selling covered calls on preexisting long positions.
Indeed, call options can lead to short-term compensation in exchange for potential profits further down the line. The advantages of doing this are most pronounced when you expect the market to trade sideways, and can help in reducing downside risk while still benefiting from the option’s initial cash premium.
However, there are risks to writing covered calls as well – and you can lose money if the market suddenly drops by a large amount too. In this situation, you would have been better off if you had just sold the stock outright, instead of implementing the option strategy in the first place.
Also, if you decide to sell your underlying stock before the expiration date for the option, you’d now be holding the call “naked,” which comes with all the risks of a typical short sale, that, in theory, can lead to what are essentially unlimited losses.
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