Investing 101: How to Invest in a Bear Market

You can also make money in a bear stock market.

There is no magic bullet that I know of. You can wait it out and continue to hold your positions, or take risks and buy put options or go short in the falling market, if it falls more.

Currently

As I write this now in December 2008, it was recently announced we have been in a recession for one year. The DJIA has dropped by 6,612 points from its high in October 2007 to the current low of 7552 point in November 2008. That is a drop from high point to low point of 46.68%. Now it’s up 14% since the low point.

If you didn’t sell your funds and stocks out of your 401k, IRA, personal accounts by now, don’t. It is too late to sell anything. Hindsight is 20/20 and nothing we can do about the bear market. If you did sell most everything by now and your money is in some money market account, fine. Are you waiting for a sign that the market is about to turn around, how will you know.

A bear market is usually defined when the market (or specific index) declines by 20% or more from the previous high. The average length of a bear market lasts between 9 months and 1 year 3 months.

One thing about bear markets is that you never know when they’re over until many months later. Most of the time you don’t even realize the bear market is over until there has been a 50% movement to the upside By looking at charts months later, that’s when you start hearing analyst say the bear market ended 5 months ago. If you wait to find the bottom then you can actually miss the biggest part of the rebound while sitting on the sidelines waiting.

History

By looking at past bear markets and their intensity and length of time we can hopefully see how bad we’re at and how long it might last. With a bear market and recession, the length of time can be the most worrisome. The stock market and economy have always come back, but sometimes it can take a long time. And the worrisome part now is for people who might need their retirement funds before this market turns around.

Since World War II there has been 16 recessions and recoveries, this is the 17th. Since 1885 there have been nine times where the DJIA has fallen 40% or more. Since 1885, there have been 34 defined bear markets, and every time the markets have recovered. The start of a bear market, the 20% decline from the previous high does not mean that the previous high was an all time high either, just a drop of 20%.

What history tells us

During a bear market there are upward corrections of 10% or more, only then to drop back into the ongoing bear market. You will hear phrases like “dead cat drop” or bear market rallies, which can fake you out. People buy only to sell again when the bear resumes. The bear market of 1973-1974 when the Dow dropped 46% had three upside corrections.

Bear markets do finally turn around and become a new bull market. In 1974 the DJIA lost 46% and one year later it had gained 49%. In 1987 when the DJIA lost 41%, one year later from the low point the DJIA was up 32%.

What you can do now

It is very hard to time the market so the best course of action would be to continue to buy shares of mutual funds or ETFs. Why should you buy in a bear market, think of it this way, you are buying something at a cheap price that will most likely go back up in price. You are buying stocks and or sectors of industries right now that are on sale, one heck of a sale. Accumulate shares now when everything is on sale.

If your money is still in stocks and funds, then you have lost about half of what you had, how do you recoup this money, time, wait for the next bull market. If you took your money out, the big question is when to put the money back into stocks and mutual funds. You can make a plan to do this once the market has gained 16% from its low, or something else you feel comfortable with. You don’t want to wait too long or before you know it, the market will be in full recovery and you will have missed a great deal of that.

It might be better to start putting your money into mutual funds instead of individual companies. You will broaden your chances of catching the first leg up of a new bull market when you have the entire market covered such as in an index fund.

A more risky approach to getting your money back, if you really think this market is going to continue to go lower, you can buy ETFs that short the market, that is these funds go up when the market goes down. If you still have all of your money into stocks and funds, you can buy these funds that short the market which will go up if the market continues down, in effect hedging your portfolio against further losses.

In trying to recapture your lost money, you can put some of your money into sectors you think will recover first. Some think that the first that went down will be the first to go back up and that could be the housing and homebuilding and banking sectors. The last thing you want to do now is to lose more money, and when people start to panic and feel they have to do something, in this case trading in and out of funds or stocks, they end up losing a lot more. And it’s hard to move fast enough to move in and out of this very volatile market.

There is a saying by Warren Buffet “Be fearful when others are greedy, and greedy when others are fearful”.

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Sam Montana © 16 December 2008

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