CFDs are a leveraged product and can result in losses that exceed deposits. Please ensure you fully understand how CFDs work and what their risks are, and take care to manage your exposure. CFDs are a leveraged product and can result in losses that exceed deposits. Please ensure you fully understand how CFDs work and what their risks are, and take care to manage your exposure.

Trading in a bear market

Bear markets offer the potential not just for selling, but for going on long rallies as well.

The rout in equities over the past few months has seen many indices either move or fall further into a ‘bear market’. While it is not easy to define such an event, at least until it is over, the standard definition is that such a market takes place once stocks have fallen 20% from their previous high.

These often accompany recessions, but not always, and this is a key part of the current debate, namely whether the current weakness in equities presages a more sustained downturn in the global economy or whether it is merely a reaction to the strong run of performance seen in US equities since the last presidential election.

In a bear market, prices tend to fall. But it is important to remember that prices do not move in straight lines. As traders, our job is to pick our moment to enter trades carefully, ensuring that risk management is employed to ensure that potential losses are kept to a minimum.

It is rarely as simple as pressing the ‘sell’ button and allowing the trade to take care of itself. Those looking to go with the trend and take short positions are, for the duration of the bear market, likely to enjoy successful trades, but it is important to pick their moment. The chart below shows the S&P 500 from mid-2007 until mid-2010.

The index dropped below the 200-day simple moving average (SMA) towards the end of 2007 and continued to decline until April 2009. While overall it dropped from around 1500 to a low near 600, it was not a straight-line move.

Over the period, there were several intense rallies, gaining 15%, 9.5%, 27% and a remarkable 40%, with the last marking the beginnings of the post-2009 bull market.

Thus, those looking to take the short side should be aware that the potential for sudden rebounds exists. Indeed, since most investors are ‘long-only’, there will be plenty of buying into weakness as investors look to pick up bargains. This can develop into the kind of rallies we saw in 2008.

US markets are only just on the cusp of a bear market, but others have been falling for over six months. To take a popular market, the DAX hit an all-time high in January 2018, but from May onwards a downtrend really kicked in.

The red rectangles mark lower highs, but preceding these were a number of rallies that saw the market surge an average of 5%. Each new lower high was a good selling opportunity, but it required timing, and the use of either an indicator like stochastics or moving average convergence divergence (MACD), or breadth such as the percentage of stocks in the index above the 20-day moving average.

Indeed, while in bull markets it rarely makes sense to stay short for any length of time, in bear markets there is far greater opportunity to buy the dips and then sell the rallies. It is rarely the case that the market simply falls each day. Rather, being judicious about short positions and also being open to the idea of going long when rallies develop can be a fruitful strategy.

Read more about the top 5 trading strategies

This information has been prepared by IG, a trading name of IG Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients.
CFDs are a leveraged products. CFD trading may not be suitable for everyone and can result in losses that exceed your initial deposit, so please ensure that you fully understand the risks involved.

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