Bear markets signify impending losses for an investor, but only those with the right investment strategy know how to make money in a bear market.
The key to success is diversification. You can get through a bear market without losses if properly diversified.
Generally, investors pull out their investments when there is a downturn market. Although, this investment strategy is justified as no one wants to lose money intentionally, there are still ways to take advantage of the situation and make money in a bear market.
But you must first keep your fear in check and ensure you are investing what you can only afford to lose.
This article will take you through eight smart ways to help you make money in a bear market.
What Is A Bear Market?
A bear market can be defined as a period in the stock market when prices fall by 20% or more on average. They are often associated with falls in the general market or index like the S&P 500.
Individual commodities are not left out, as we can consider them to be in a bear market if their prices fall by 20% or more over a long period.
Bear markets occur during an economic recession or depression and differ from bull markets.
Although bear markets are associated with a negative stock market season, there are still opportunities to make money for investors who know the right strategies.
This leads us to our next discussion on how to make money in a bear market.
How To Make Money In A Bear Market?
For agile and active investors, a bear market doesn’t mean that no profit can be made. Bear markets provide opportunities for long-term wealth building for investors.
Here are 8 ways to make money in a bear market as an investor.
#1. Short Selling
Short selling, also called short position, is an investment strategy experienced investors use during a price fall in the stock market. It occurs when the investor borrows shares to sell back with the belief that the stock price will fall in the future.
If it goes as planned, and the price drops, you can buy the borrowed shares at a lower price to cover the short position and make a huge profit.
For example, if you borrow stock XYZ at $40 per share and the stock price declines to $30, you can buy the stock back at $30 to close out the short position. Your profit here would be $10 per share.
However, the risk of loss on a short sale is hypothetically unlimited since the price of any asset can rise massively.
#2. Buying High Yield Dividend Stocks
Searching for dividend stocks can be a good way to find profit opportunities in a falling market. This is because the company’s net income backs dividends while the stock market traders determine stock prices.
If the stock prices decline, but the company is still generating income and paying dividends, it is a good opportunity for those seeking profit from dividend stocks.
You can use stock screeners to find dividend-paying stocks. See our list of free stock screeners you can use here.
#3. Put Options
A put option becomes more valuable as a price option decreases. In a bear market, a put option is when an investor has the right but not the obligation to sell or short-sell a stock at a particular strike price. ( A strike price is a pre-determined price the buyer of the put option can sell the stock).
A put option becomes more valuable when the underlying stock keeps falling. If the stock price goes beyond the strike price, you can sell it at a higher strike price or decide to sell the put option. Remember the put option differs from the call option (which we’ll explain shortly)
However, just like short selling, a put option loses its value if the price of the underlying stock increases.
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#4. Short ETF’s
Short Exchange Traded Funds, also known as Inverse ETF is another investment security strategy that involves the collection of stocks that produce returns when the underlying price declines.
Using ETFs is like short selling, but its difference is that the returns produced are inverse of the market index. This inverse relationship of ETFs makes it appropriate for investors who want to hedge against such a market downturn. It is also a good way to diversify into different sectors.
Short ETFs enable investors to make money in a bear market, without having to short-sell. Although they are not considered as long-term investment strategies, they are an alternative to short selling as your only loss is the amount you invest in ETF.
#5. Buying Call Option
A call option is an assurance that a specific stock will increase in value within a short period.
Buying call options is about playing the market, not investing. Remember, a call option is secondary and can expire if you’re not careful.
However, the good side of a call option is that it is not expensive to buy and is a very cheap stock at the bottom of the stock market.
#6. Writing Covered Calls
Writing a covered call means selling an option against a stock you own. This means that you accept an obligation to sell your stock to the holder (buyer) of the call option. If you sell the stock to the buyer when it exceeds the strike price, you receive a premium option (known as the income).
Investors may contemplate selling their shares when the market diminishes to avoid losing money. Writing covered calls is a good way to make money from the bear market. The buyer hopes the market will pick up, but if it doesn’t, you get to keep your premium option.
Another good side to writing covered calls is that whether the holder uses their call option, you will receive your premium for taking the risk of writing a covered call.
#7. Acquire Defensive Stocks
A good way to secure your investment is to gain defensive stocks. They are stocks of companies that provide consumers with usable so their product is constantly in demand regardless of the economic situation. A typical example of a company is food and beverage manufacturers.
In a booming economy, investors move into “cyclical stocks”. These are stocks from companies that manufacture needless products like electronics, autos, machines, etc. stocks from these companies do well in such an economy.
However, in a declining economy, good investors move to stocks of companies that produce consumer needs. This secures their investments and they make money in the bear market.
#8. Buy Good Stocks
In a bear market, the value of both good stocks and bad stocks go down. But good stocks recover and go back to growing, while bad stocks stay down till the bear market ends.
As an investor, the master plan is to identify stocks of strong and reputable companies whose prices declined and invest in them. But you will also have to conduct thorough research about the stock and company, regardless of whether it is a good stock.
You can use a bond rating to determine if the company is safe and creditworthy. Ratings of AAA, AA, and A signify that the particular company has reached a high level of creditworthiness, while lower ratings like B and C are flagged as risk investments,
Basically, before you know how to make money in a bear market, you have first to understand the bear market. This leads us to our next discussion.
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Understanding The Bear Market
A general definition of a bear market says it occurs when there is a 20% fall in stock price. When this happens, more investors switch from risk-seeking to risk-aversing investments because bear markets can last long.
Different factors can lead to a bear market, but the major factors that show that there is an impending market are:
Declining Economy
A weak and falling economy is a major sign of a bear market. Low-income rates, a reduction in business profits, rising inflation, and low employment see a low economy. When all these happen consistently, the stock market will experience a downturn.
Failed Market Rallies
When an uptrend has no purchase, there is an impending bear market (downturn) and the bulls are no longer in control.
Investors who see this know that something is about to happen and hence sell off their stocks to avoid losses
A real-life example of a bear market in the US stock market is seen below from Investopedia
In February 2022, global stocks entered a sudden bear market in the wake of the global coronavirus pandemic, sending the DJIA down 38% from its all-time high on February 12 (29,568.77) to a low on March 23 (18,213.65) in just over one month. Though the S&P 500 and the Nasdaq 100 both made new highs by August, the DJIA failed to do so.
Conclusion
Bear markets are also a good opportunity to make a profit. There are multiple ways to make money in a bear market.
So long as you are a long-term investor, a bear market shouldn’t make you panic. The right investment strategy would keep you from losing money in a bear market.
If there’s anything you would like me to add, kindly let me know in the comment section.
I hope this article helps you.
Good luck!
See These Also
- How to Invest: A Beginner’s Guide to Investing in the Stock Market
- 10 Low-Risk High Reward Stocks In 2023 | Wealth Investment
- How To Make Money In The Stock Market in 2023: Full Guide.
- Motley Fool Rule Breaker Review 2023: Is It Worth It?
- Motley Fool Stock Advisor Review 2023: Is It Worth It?
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