How to trade in a bear market: top 5 strategies
Bear markets may signal receding economic conditions, but they also contain opportunities. Get bear market insights, including the possible outcomes when using bear market trading strategies.
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What is a bear market?
A bear market is a period during which prices fall significantly following recent highs – this is normally indicated by a minimum price drop of 20%. When this happens, investors may opt to withdraw their money to avoid fading yields or cut their losses. With negative investor sentiments on the rise, prices are likely to tumble even further, making it risky to invest in a bear market. This can also spiral into higher unemployment levels, a decline in consumer spending and deflation.
Like in a bull market, the occurrence of a bear market is influenced by supply and demand. In a bear market, supply is high and demand is low, the inverse of which applies to bull markets.
Bear market example
Here’s a visualisation of the bear market definition:
This chart shows the price movements of the FTSE Mid 250. The 20% decline, which stretches over approximately three weeks, from February 2020 to March 2020, marks the occurrence of a bear market. This bear market was triggered by the Covid-19 pandemic. The chart also depicts the beginning of the recovery period after the bear market had run its course.
With the price action having declined beyond 20% from recent highs, this fulfils the definition of a bear market.
How to trade in a bear market
With us, you can trade in a bear market, speculating on price movements using CFDs. Trading in a bear market is commonly unpopular due to tanking prices and, therefore short-selling is a more favoured choice.
Short-selling enables traders to speculate on a falling share price, and if the prediction is correct, make a profit. It’s important to note that even in bear markets, the price action could go either way. So, if the share price happens to rise, a loss will be incurred.
Top 5 bear market trading strategies
Bear market strategies can guide you in navigating through trading when negative performance is coupled with high investor uncertainty. Here are some popular strategies to keep in mind:
Take a short-selling position
As the saying goes, ‘the trend is your friend’. Short-selling is a way in which you can follow the directional momentum in a bear market – you’d take a sell position (go short), by speculating on falling market prices. If your prediction pans out, you’ll make a profit. But even in bear markets, prices can move either way. So, you’ll incur a loss if the price action moves against your position.
Find a good entry position
When the decline in price hits the 20% mark, it’s official - bear market territory has been entered. If looking to short-sell, for example, this could be a good point to open the position. Even though the price is likely to continue dropping, it’s impossible to know for how long it’ll keep falling, or whether it’ll continue to drop at all. If it does continue, there’s also no way of knowing how long the decline will last (the next strategy addresses this).
Take profits at regular intervals
The probable price action direction in a bear market is descending. This could be an opportunity to lock in profits regularly, but it’s important to remember that prices can move up every now and then, even in bear markets.
Trade indices and ETFs
While indices such as the FTSE 100 represent a basket of stocks by company market capitalisation, exchange traded funds (ETFs) track the performance of a market, for example: a country’s stocks, an index or sector. With bear markets often being triggered by supply and demand factors, and in turn impacting economic conditions, such broad exposure to related assets offers an opportunity to benefit from the expected similarities in price movements. Naturally, if the actual price movements go against the grain of expectations, this would spell losses.
Set a stop loss order
A stop-loss order is an instruction that enables you to exit a position automatically once a certain, less favourable price is reached. Therefore, if you’re short-selling, your stop-loss order would be at a price that is higher than the one you opened your position at, and vice versa if you’re going long. This risk management strategy helps you cut losses if the market moves against you.
Though these strategies are based on past performance, they don’t guarantee future results.
How to start trading with us
- Create an account or log in
- Find the market you want to trade on our trading platform
- Select ‘buy’ or ‘sell’ in the deal ticket
- Set your position size and take steps to manage your risk
- Open and monitor your position
With us, you’ll trade with leverage – this means you’ll only need a small deposit, known as margin, to gain full exposure. Your profits can be magnified by leverage, but so can your losses. So, it’s important to manage your risk appropriately beforehand.
What are the best investments strategies in a bear market?
The very notion of best investments strategies in a bear market may seem ironic and counterintuitive, but there may be opportunities. For instance:
- Focusing on the long term: despite significant declines in price during bear markets, some investors have a positive long-term outlook of the market, and therefore hold on to their investments
- Sell your investment: though some may opt to ride it out and hope for a strong comeback, selling out upon bear market territory entry is regarded by many investors as the obvious choice to cut possible losses
- Buy low and sell high: buying at bear market prices may be lucrative in the long term. Although a recovery to previous highs is not guaranteed, the yields could be worthwhile. But remember, the bear market could also continue into the long term, making losses on the investment probable
Bear market vs economic recession: what’s the difference?
Bear markets are closely associated with economic recessions as either tend to trigger the other. Plus, they are similar in several other ways. Still, they differ fundamentally.
- Bear market: a period of a continuing decline in the prices of a market
- Economic recession: a general decline in economic performance, often signified by two consecutive quarters with negative growth or reduction in the gross domestic product (GDP).
The intrinsic link between these concepts is evident in factors such as their causes and effects, for example: geopolitical crises, pandemics, investor sentiments and consumer spending.
What are the different types of bear markets?
There are three types of bear markets – they're classifications of what brought the downward-trending prices on.
- Cyclical: a cyclical bear market is set off by rising interest rates and high inflation rates at the end of a business cycle
- Structural: a structural bear market occurs when a financial bubble or other economic imbalance collapses, example: the global financial crisis
- Event-driven: as the name suggests, an event-driven bear market is caused by a specific, significant event, eample: Covid-19
Bear markets vs bull market: what are the differences?
Knowing the differences between a bear market and a bull market is important as this contributes to the effectiveness of trading strategies. If a short-term correction of a bull market is confused with a bear market, for instance, the expected outcome will probably be drastically different.
Here are some of the main differences between bear and bull markets:
Significant fall in a market’s price of at least 20%
Supply is high and demand is low
Typically associated with a receding economy
Bearish sentiments are prominent due to the high loss potential on investments. With more investors withdrawing their money, the price could fall even lower
Profits are more likely to be realised from short-selling, and selling investments early in the bear market can help in cutting losses
Upward-trending growth in a market that occurs over a prolonged period
Supply is low and demand is high
Typically linked to a sound economy
With high investor confidence, coupled with an increase in buying the physical, underlying asset, the upward trend could rise even more
High probability of making a profit from long positions and buying physical assets to sell at a higher price
Learn about stock market rallies, and the difference between bull and bear rallies
Trading in a bear market summed up
- A bear market occurs when there’s a significant fall in prices, typically at least 20%, following recent highs
- Bear markets are linked to a receding economy and a market outlook that is chiefly negative
- Profiting in a bear market may seem ironic and unlikely, but opportunities do exist
- While there are always risks involved in trading activity, buying and owning physical assets in a bear market is particularly risky
- Bear market trading strategies can be useful as they’re based on the past performance, but they don’t guarantee future results
- Bear markets and recessions are intrinsically linked, but differ fundamentally
- Knowing the differences between bear and bull markets is crucial as this can affect the success of your trading strategies
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