Bear markets are a sign of 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. If you are properly diversified, you can get through a bear market with no losses.
Generally, investors tend to pull out their investments when there is a downturn market. Although, this investment strategy is justified as no one wants to intentionally lose money, there are still ways to take advantage of the situation and make money in a bear market.
But you have to first keep your fear in check and ensure that you are investing what you can only afford to lose.
In this article, we 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 they can be considered to be in a bear market if their prices fall by 20% or more over a long period of time.
Bear markets occur during economic recession or depression and are different 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. As a matter of fact, 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 used by experienced investors during a price fall in the stock market. It occurs when the investor borrows shares to sell back with the belief that ithe 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 dividends are backed by the company’s net income while stock prices are determined by the stock market traders.
If the stock prices decline, but the company is still generating income and pays dividends, it is a good opportunity for those seeking profit from dividend stocks.
#3. Put Options
A put option becomes more valuable as a price option decreases. In a bear market, a put option 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. Bear in mind that 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.
#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 similar to 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 of time.
Buying call options is about playing the market, not investing. Remember, a call option is secondary, and it can expire if you’re not careful.
However, the good side of a call option is that it is not expensive to buy and tends to be a very cheap stock at the bottom of the stock market.
#6. Writing Covered Calls
Writing a covered call means that you are selling a call 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 choose to sell the stock to the buyer when it exceeds the strike price, you receive a premium option (known as the income).
When the market is diminishing, investors may be contemplating selling their shares away to avoid losing money. Writing covered calls is a good way to make money from the bear market. The buyer hopes for the market to 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 makes use of 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 acquire defensive stocks. They are stocks of companies that provide consumer usables so their product is constantly in demand regardless of the economy situation. A typical example of these kind of companies are food and beverage manufacturers.
In a booming economy, investors tend to move into “cyclical stocks”. These are stocks from companies that manufacture needless products like electronics, autos, machines, etc. stocks from these companies tend to do well in such an economy.
However, in a declining economy, good investors tend to 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 tend to 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 have to carry out a thorough research about the stock and company too regardless of if 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 signifies 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 can know how to make money in a bear market, you have to first understand the bear market. This leads us to our next discussion.
Understanding The Bear Market
A general definition of a bear market says that 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 for a long period of time.
Different factors can lead to a bear market but the major factors that indicate that there is an impending market are:
A weak and falling economy is a major sign of a bear market. The low economy is seen by low-income rates, a reduction in business profits, rising inflation, and low employment. When all these start to happen consistently, the stock market will experience a downturn.
Failed Market Rallies
When there is an uptrend that has no purchase, it means that 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.
Bear markets are also a good opportunity to make profit. In fact 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 will like me to add, kindly let me know in the comment section.
I hope this article helps you.