Most major stock indexes across the world are down this year. This is as a result of a shift in macroeconomic conditions, rising raw material costs, rampant inflation, and war drums in Europe. The most prominent indexes in the United States, the S&P 500, the Dow Jones Industrial Average, and the tech-heavy Nasdaq 100, are down by 18%, 14%, and 26% respectively since the year started. The question is, can people make money trading in a bear market?
The answer is yes. In this article, we share five tips to help our readers make the most out of a negative cycle in the stock market.
1. Buy Cheap Stocks of High-Quality Companies
There’s a saying in Wall Street that, during a crisis, all correlations go to 1. Even though some may disagree that the markets are in crisis mode right now, the performance of equities so far this year is saying otherwise.
With a significant number of stocks shedding over a quarter of their value, one could find some low-hanging fruits in the marketplace that are being sold off just because panic is reigning.
These are companies whose fundamentals and business model remain strong despite the current headwinds but whose valuations have suffered amid a temporary wave of negative sentiment in the marketplace.
2. Focus on Long-Term Returns
In the short run, volatility may lead to further losses, even if investors have focused on buying the most fundamentally undervalued businesses out there.
However, in the long run, the market will typically recoup its composure and will once again recognize the earnings and cash-flow generation capacity of the business. As a result, valuations will usually return to or near fair levels at some point down the road.
Those who are patient enough to wait until the storm passes may reap the benefits of having a long-term perspective.
3. Don’t Go Against the Federal Reserve
Making bets that go against the trend of what the Federal Reserve is doing is typically considered a bad approach during both bear and bull markets. At times when the United States central bank is adopting dovish measures. These include reducing interest rates and flooding the market with liquidity. The odds are in favor of a bull market.
In turn, when the institution is raising rates and reducing liquidity, like now, the Fed’s actions are setting the stage for a bear market. Therefore, investors may opt to increase the weight of their short positions. This is to the point that they may exceed long ones in absolute and relative terms.
Meanwhile, investors could hedge their portfolios against what could be a prolonged downturn. This can be achieved by buying derivatives like put options. This offsets a portion of the losses their equity positions could experience. This is if the market keeps heading south with the gains produced by these instruments.
4. Ignore the Noise, Follow the Signals
Bear markets will eventually come to an end once market participants have fully priced the impact of all the headwinds that are affecting the performance of companies within the global economy.
One good example of this is the 2020 pandemic crash. Back then, the market hit bottom in March. This is when the Federal Reserve pulled all its backstops to prevent a financial catastrophe.
Nobody knows which specific action could define the ultimate bottom for the markets in the current environment. It could be the end of the war between Russia and Ukraine. Or the Fed’s success in reducing inflation without necessarily engaging in quantitative tightening.
In any case, investors should pay more attention to signals that the market has bottomed than the noise produced by media outlets and commentators. Since they may continue to cast doomsday predictions even when everything points in the opposite direction.
5. Don’t Try to Predict the Bottom
One of the worst approaches when it comes to investing in the financial markets is to try to “time the market”. This involves telling the exact moment in which a bull or bear market starts and ends. With the expectation of making the most out of the rally and avoiding the bulk of the losses produced by the downturn.
Most studies point out that no one can accurately predict when the stock market will do anything. Since too many variables exist to consider. Additionally, the unforeseeable nature of most of these events makes the task nearly impossible.
With this in mind, the best way to make money in the market is to stay invested and make tactical moves whenever it could be convenient. Additionally, implement adequate risk management protocols to limit losses as much as possible if things don’t go as expected.