If the bear market between 2000 and 2002 was the wound, the bear market of 2008 could be considered the salt in the wound. Despite tremendous gains in the late 90′s as well as between 2002 and 2007, by the end of 2008 the market was back to values seen in the last 90′s. Investors essentially wasted more than a decade. Yet, it didn’t have to be that way if some simple techniques had been part of an investing strategy.
Some of these tactics are more advanced than others, such as the use of options, or employing inverse leveraged ETFs. Don’t be intimidated by any of them. Investors of all skill levels can learn and apply these ideas.
Above all other rules, this one is the most important of all … don’t lose big. Small losses are part of the game, as you have to give stocks a little wiggle room. Letting a small loss turn into a large loss is just sloppy.
Of course, there’s no set amount of how much of a loss is “too much”. For long-term stock investors, a retreat of 8% from any peak may be a good exit point. For short-term scalp traders who aren’t even looking for an 8% gain on a trade, stop-losses of 1/3 of the targeted gain are reasonable. For option traders, a 30% berth may be required. It’s all relative.
The use of inverse ETFs (exchange-traded funds) is another easy way to profit from a decline in the broad market, or a decline in a particular sector. They simply move higher when those indices or sector move lower, yet these ETF can be bought and sold like any other stock.
Not only are inverse ETFs available, leveraged inverse ETFs offer a potential gain that is greater than the potential demise of its index or sector. A double-leveraged ETF will rise by twice as much as that index falls, but there are even a few triple-leveraged ETFs now available.
There’s only one caution to keep in mind regarding the use of inverse exchange-traded funds – they’re only of value on a temporary basis, since they lose value when stocks rise just like they gain value when stocks fall. Like most portfolio hedges, you don’t want to buy them and forget about them, as stocks always move higher given enough time.
For traders who are skilled at spotting stocks on the verge of a decline, selling them short is one way to profit from that skill. With a short sale, a trader simply sells a stock at a high price, and will later buy the stock back at what is hopefully a lower price. A margin account is required to use this tactic.
But what about the horror stories we’ve all heard about margins accounts and short sales that went awry? While those stories may be true, they are few and far between… and almost always the result of poor discipline on the part of the investor rather than the account or trade itself.
Finally, index and equity options can give you a chance to make money from a decline. Specifically, put options increase in value when the underlying index or stock moves lower. The great advantage options offer over other bear market strategies is choice… you can choose your degree of risk and leverage by choosing certain strike prices and expiration dates.
On the flipside, options eventually expire, while stocks and ETFs don’t. The trade-off is simply that options can cost a fraction of what it would cost to take on an equivalent position in a stock or ETF, essentially making option trades a ‘disposable’ hedge.
One last thought – though it’s not a ‘bear market strategy’ per se, it’s still worth knowing that even in the worst of any bear market, odds are good that some stocks, from somewhere, is going higher. If you’re willing to look a little more closely than normal, they can be found.
The ultimate message should be simple… it doesn’t take a genius to survive a bear market – it just takes a little action, and some willingness to learn how to do a few new things. Don’t let another downturn push your portfolio in the wrong direction.
