How To Protect Yourself From Bear Market?

By: Rupesh Oli

Introduction

Stock market operates in cycles exemplifying both the bullish and bearish trends. As you invest in a particular stock, it is unlikely that its price will continuously go up. Hence, it depicts ups and downs in the market. The minor price correction in the market does not signify the bearish trend. It is because the price probably might have dipped down to hit or break the previous resistance it made. For instance, let’s suppose a particular stock is trading at Rs. 2850 on NEPSE (Nepal Stock Exchange) and its price lowered down and hit Rs. 2650-2700 on the market within a few days. In such circumstances, the majority of the investors might speculate that the bear trend has begun to take place. However, it is very necessary to analyze whether the stock’s price dipped down so that it could hit another high, or is it the signal of the next bearish trend on the market?

It is therefore vital that every investor must be aware of the percentage drop in the price, a bear market signifies. 20% drop from the recent high connotes the bear trend in the market. Hence, the price has not been traced back by a huge margin on an instance I just showcased above. If the price would have been drawn back by the higher percentage margin, then the scenario would have been completely different. It is also to be noted down that the trend whether it be bearish or bullish is just an indicator to get more closer to the probable outcome signifying what could possibly occur in the coming days. It is therefore not advocated to any of the investors blindly follow what the technical analysis indicates. Instead, s/he must analyze the bigger picture by analyzing what external factors could have impacted the particular stock to go up or down in the market.

A bear market can be defined as the general decline in the stock market over the period of time depicting a transition from high optimism of an investor to widespread fear and pessimism. As just mentioned before, a price decline of 20% or above over at least two months of period denotes a bear market. However, the fall of 5% or 10% in the market is considered as a correction in the market. In the bear market, stocks break down the previous support they made, on a back-to-back basis creating havoc among the investors. In order to make a recovery from the bear market, an investor can expect a considerable amount of time to get back to the price from where it has started to fall down. A bear market can be seen on the market as a whole, for instance, S&P 500 or the Dow Jones Industrial Average, or for individual stocks in particular.

A bearish trend on an individual stock might not impact the market as a whole. However, when the whole market enters the zone of a bearish trend, it is for sure almost all stocks start to fall down, no matter how strong an individual stock is on its fundamentals.

You May Also Like:

Bull Vs Bear Market: Features and Investing Strategies

Pump And Dump In Stock Market: How To Recognize It And Protect Your Investment?

What Causes a Bear Market?

There exist multiple possible causes for a bear market. One of the primary signals can be taken as the economic turmoil that could possibly outrage in the coming future with many indicators denoting its strong occurrence. Let’s take the example of COVID-19 that we all have gone through. The expected spike in unemployment, widespread closures that took place simply provided the investors that the economy is going to struggle for sure in the coming days. When they saw such events impacting the economy negatively, they expected corporate profits to decline in the near future. As a result, they started selling the stocks they acquired which ultimately pushed down the market lower. At last, it all boils down to the investors’ fear and uncertainty regarding the market movements leading them to panic selling. Further, events that are completely outside one’s control can lead towards the bear market. For instance, natural disasters or war.

If we take a look towards the cause of the bear market, then the game of supply and demand comes into play. It is obvious that stock price fluctuates based on the supply and demand of the stocks. In the case of a bear market, supply will be more than the demand implying there will be more sellers than buyers in the market. In such circumstances, more sellers are willing to sell their stocks, however, very few buyers are willing to buy. Therefore, sellers have to lower their selling rate in order to make the transaction take place. Stock’s price fall down, as a result, because sellers will sell the stocks at any cost due to the fear and uncertainty surrounding them. Let’s take an example, Mr. A has acquired 100 stocks of company B and the stock’s price is currently trading at $1500. As s/he gets informed about uncertain events that are going to take place in the coming days pushing the market towards the bearish trend or let’s suppose s/he is experiencing the market going down on a back-to-back basis in the contemporary context (suppose: Market index of 4000 reached to 3300 within a week). As a result, Mr. A will try to perform panic sell in the market due to which s/he will be ready to sell the stocks regardless of loss they are expected to deal with. In the end, if s/he sells the stock at $1100 which was trading at $1500 a couple of days before, the stock of that particular company is sure to decline. This is how the price gets, even more, lower within some period of time in the bear market.

Hence, it is crucial that investors need to have some sort of knowledge on the methods to protect themselves from the bear market which will be elaborated in the latter section below.

Few Instances Depicting the Bear Market (International + Nepal)

The Wall Street Crash of 1929 crashed the market by 89% as the Dow Jones Industrial Average’s market capitalization went from 386 to 40.

A long-term bear market from 1973 to 1982 comprised the 1970s energy crisis and the unemployment of the early 1980s.

Harshad Mehta Scam of 1992 in India.

Bear Market of 2007-2009 because of the recent financial crisis experienced in the year 2008.

2015 Chinese stock market crash.

Bear Market of 2065 BS to 2068 BS in NEPSE where the index dropped from 1,175 to 293.

History of NEPSE: Battle Of Bulls And Bears (A Study Of 23 Years)

How to Protect Yourself from Bear Market?

1. Avoid Panic Selling

One of the common mistakes that the majority of investors start performing in the bear market is the panic selling of stocks they acquire. Instead, they should be avoiding their knee-jerk reactions to the contemporary market event they are surrounded with. If you start panic selling, it is obvious that you would be facing a permanent loss of capital. You must have a long-term vision regarding where the market is going over the coming few years. It’s not like the market will continue to go bearish forever. We have witnessed bear markets before, and it is also the fact that the market has recovered and set another high if taken a look at the historical chart. The longer you stay invested, the higher is the probability of acquiring lump-sum profit in the long run which would otherwise have been sold out with a hefty loss booked during the bear market.

2. Dollar Cost Averaging

In the previous article where I wrote about dollar cost averaging, I mentioned it to be one of the effective strategies when it comes to stock investing, and as an investor, if you still have no idea of dollar cost averaging, then you need to know it right now. All you require is a certain amount of cash to invest at regular intervals rather than performing the lump-sum investing at once. If a certain stock’s price falls from 300$ to 230$, then you would also have the chance to buy that particular stock at 230$. Basically, you would be getting the stocks at the discounted rate which would not have been possible if you would have bought all the shares at once (300$). Hence, it ensures that you do not invest all your hard-earned money at the point where the stock was at its highest peak.

On one hand, bear markets are one of the dreadful phases to pass through. On the other hand, it is the perfect opportunity to purchase the stocks at lower prices possible. Hence, what you require is a change of perspective regarding the bear market. Instead of taking it as the phase of potential losses, embrace it with the main motto of potential gains that you would be garnering once the market recovers to its normal phase.

3. Short Stocks

If you haven’t shorted a stock before, this might be quite trickier. However, it is to be noted that stock shorting is not allowed in Nepal, however, in countries like India and USA, it is very common. In simple terms, you borrow the stock, sell it and ultimately you have to buy back the stock in order to return the stock you previously borrowed. So, the difference margin is all your profit. Traders however need to be very aware that the potential loss from stock shorting is unlimited.

4. Bonds and Dividend Paying Stocks

Bonds can be considered as one of the finest alternatives during the bear market as their price often moves in the opposite direction of the stock prices. Bonds are something that should not be missed out as incorporating high-quality and short-term bonds into your portfolio relieves your pain during the bear market.

In the bear market, although the stock prices get lower down as the day passes by, many investors can still get paid in the form of dividends. It is therefore crucial that you better not ignore to include higher-than-average paying dividends stock in your portfolio so that you do not miss out on leverage from the stocks even in the bear market.

Top 10 Highest Dividend Paying Stocks In Nepal

5. Diversification

One of the most valuable strategies to consider is the diversification of your holdings. Consider the S & P 500 index or NEPSE index as they represent the overall market, but does fall however not necessarily by a similar amount as individual stocks. Hence, diversification minimizes the risk. Instead of investing all your capital in a single stock, consider the well-diversified portfolio in circumstances such as market turmoil, which would ultimately minimize your portfolio’s overall losses.

Conclusion

To sum up, we, as investors, have to pass through the phase of a bear market. If there exists optimism in the market, there exists pessimism too. Similarly, if the market experiences a bullish run, it depicts the bearish run as well. However, investors need to have some sort of strategy or tactics that they can deliver to cope up with the market when it turns bearish. If s/he possesses adequate knowledge considering what causes a bear market and the possible ways to deal with it, s/he will definitely be confident to deal with the market, when the bear trend begins to take place the next time. However, in order to learn through the practical implications, it is not mandatory that you start directly with tangible capital on hand. You can definitely go through paper trading (the virtual experience), and once you possess some sort of idea on how the market works, what factors affect the market and what sort of strategies can be applied to book profit and recover from losses, you then are welcome to the actual world of investment filled with lots of jargons, yet to uncover.

From The Author:

What Is Loss Aversion? How It Affects Decision Making Process?

What Is Survivorship Bias?

(Liked this article??? If you are also interested in publishing your articles related to business, finance, and economics, then mail us your article at Investopaper@gmail.com.)