How to trade bear market?

What is a bear market?

A bear market is when stock prices fall, usually for a long period of time. It can take months or even years and has a devastating impact on the economy.

This type of market is characterized by a high level of market volatility as investors become increasingly concerned about future prospects, selling off their securities, which can cause prices to fall even further.

While a bear market can be triggered by a number of factors, it is most often the result of economic uncertainty or an expected slowdown in corporate earnings. Prices may have fallen significantly from recent highs during this period – and this may be indicated by a minimum price decline of 20%.

Different types of bear market

There are three main types of bear markets: cyclical, structural, and event-driven.

Cyclical bear markets are usually caused by economic recessions when businesses are forced to cut back on spending and investment. This type of bear market usually lasts one to two years.

Structural bear markets are caused by long-term problems in the economy, such as declining productivity or demographic changes. They tend to last for several years.

Event-driven bear markets are caused by a specific event, such as a natural disaster or financial crisis. They can last several weeks or months.

Taking some time to analyze what type of bear market you are in can greatly increase the chances that your bear market trading strategies will work.

For example, event driven bear markets can offer some of the best buying opportunities you will see in your trading career. This is because the phenomenon that caused the bear market is usually short-lived and the market often recovers quickly. Note, however, that all investments involve risk.

However, understanding that a bear market is structural could mean a lot more patience before suitable investment opportunities are found.

Are we in a bear market?

The strict definition of a bear market is when the stock market, often measured by a national stock index, has closed 20% down or below its 52-week high for the day.

By this definition, the S&P 500 (US500) entered a bear market on Monday, June 13, 2022.

Looking at the chart above, you can see that the index is falling from a high at "point A" of 4820 to a low at "point B" of 3635. This means that the index is down 24.6% (ie a drop of more than 20%, which defines a technical bear market).

Other global indices have performed differently, which helps demonstrate a point we'll soon see about how to invest in a bear market with diversification.

Germany's DAX 40 (Germany 40) also plunged into a bear market, down 23.9%, partly due to its geographic sensitivity to the war in Ukraine. Japan's Nikkei (Japan 225) index fell 20.4% from a high to a low before recovering.

Britain's FTSE 100 (UK100) was one of the more stable indices during the bear market of 2022. A strong weighting in energy and mining companies, which benefited from the commodity bull market, and a light weighting in volatile technology stocks go some way to explaining the outperformance.

The FTSE 100 has fallen from a high of ~7,695 at point A to ~6,750 at point B, which is around 12%. A decline of more than 10% is considered a market correction.

There is a great deal of debate among market analysts as to whether we are currently in a bear market, according to the broader definitions.
While there are some indicators that suggest a bear market may be underway, such as recent market volatility and high valuations for many stocks, there are also some indicators that suggest otherwise. For example, corporate profits are still strong and many companies are still reporting healthy growth.

How to trade in a bear market?

Here are some applicable strategies that traders can use during a bear market.

Bear market rally

A bear market is a short-term increase in stock prices during a longer period of decline. This is usually defined as a rally of at least 10% from recent lows. Buying stocks before a bear market rally is one of the key trading strategies in a bear market.

When a bear market recovers, the change in price over a short period of time can be very rapid, but it is important to remember that just because the market has recovered from a recent decline, it does not mean that the downtrend has changed. It is more likely that the rally is only temporary and not a real trend change.