It is not unusual for an investor to panic when a bear market emerges. A bear market is when the market is going down. Unfortunately, panic is the worst thing that you can do in a bear market. Instead, an investor should go out of his way to think rationally when the market is down in order to maximize profits when the market goes bullish or starts to go up.
There is an old saying attributed to Shelby Cullom Davis that you make most of your money in a bear market; you just don’t realize it at the time. The saying essentially means that you set yourself up when the market is down to take advantage of when the market that increases in value.
There are five things that every investor should consider in a down or bear market.
- Keep Your Emotions in Check
- Use Conditional Orders
- Liquidate stocks that are going down
- Watch your diversification
- Save to build up cash
1. Keep Your Emotions in Check in a Bear Market
It is especially important to not panic during a bear market. The sky is not falling. A bear market is a short-term issue that has rebounded in every single recorded case. Sometimes, the rebound is much later in time or seems slow in coming, but it does happen. Now is the opportunity to buy a great company at a reduced price. You need to think of this opportunity as if you just walked into the store everything in the store was offered at 10% off.
You can buy a Cadillac or a Lexus at the price of a Chevrolet.
2. Use Conditional Orders in ALL Markets
Whenever I make a trade for my personal portfolio, I always use a conditional order to cover my risk. This strategy is even more important in a bear market (or when the bottom of the stock may not be apparent). My standard conditional order for every trade is:
If the price of that stock drops more than 7% in one day, then I will sell that stock immediately.
I know from experience that I can catch the slow decline of a stock from one day to the next based on my indicator rules that I have manually set up for myself. You can see these rules at work on my daily postings of indicator results for my Watch List.However, I may miss a fast drop in a single day based on market conditions. In this instance, I need a conditional order to cover my investment and get me out based on bad news that I never saw coming.
If you are not familiar with conditional orders, below is an excellent video explaining the concepts. The speaker is from eTrade. Most large brokers will allow you to place conditional orders. Take the time to learn how to use this order at your broker. If your broker cannot execute conditional orders, you should strongly consider changing brokers.
3. Liquidate Stocks that are Going Down in a Bear Market
I have said many times before that you do not have to stay with the original stock to get you out of the hole. Simply put, a stock is not a date, you don’t need to dance with the one that brought you.
If a stock drops significantly, it does not mean that specific stock will recover enough to make up your loss in a reasonable time. In fact, it is almost certain that the stock will not rebound as quickly as it dropped.
If you look at how stocks drop in price, they almost always drop farther and faster than they recover. Investors are very cautious, and they avoid being burned twice. If a stock drops quickly, it’s rise will be more rational than its original drop. Therefore, it is foolish to think that a specific stock that experienced its own bull market and dropped the value of your portfolio is going to be that same stock that increases the value of your portfolio. Rather, it is more likely that a different stock is going to be the stock that increases the value of your portfolio. My advice is to get out your bad stocks and be ready with that cash to buy stocks that are rising quickly.
4. Watch your Diversification as You Grow Out of a Bear Market
As you start to liquidate poor performing stocks in a bear market, it is very possible that your portfolio will become overweight in a certain category of stocks or industry. It is also more likely that the fast risers will be in the same industry (as some industries will recover more quickly from a bear market). In these times of bear market recovery, you need to be careful that you don’t overburden your portfolio with too much of one industry.
Watch your diversification as much as you can. If your portfolio has 10 to 15 stocks, then you probably do not want to have more than two or three individual stocks in the same industry.
5. Save to Build Up Cash
There is little more important asset in a bear market than cash. You need to continue to take part of your earnings and set it aside for investment in a bear market. Do not lose your momentum by reducing your savings. As I preach across the site and in my book, The Confident Investor, you should be setting aside 10% of your after-tax wages for investments. Don’t let up on this strategy in a bear market. You need to accumulate cash so that you can take advantage of the eventual bull market that follows every bear market.
As I’ve said above, you make most of your wealth by the moves that you make in a bear market. When the market goes bad, you need to set yourself up to make more money when the market goes bullish. Good luck to you.
If you want a strategy to survive future bear markets and maximize your profit in a bull market, you should read my book. You can purchase my book wherever books are sold such as Amazon, Barnes and Noble, and Books A Million. It is available in e-book formats for Nook, Kindle, and iPad.
