Investing strategies for bear markets

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Bear markets can be very dangerous for the unprepared investor. If you’re caught at the wrong moment and without a proper investment strategy, you run the risk of losing most, if not all, of your capital. However, if you know how to navigate these markets and have a few solid investing strategies in place, you can safely make use of those techniques to not only preserve your capital, but also to generate handsome returns if possible. 

In this chapter, we’re going to focus on learning how you can do just that. Here are a few investing strategies that you can use to create wealth over the long term, even in a bear market.

1. Diversify your portfolio

By now, diversification is a term you may have heard plenty of times. Well, that’s because it’s an extremely good strategy that holds its relevance irrespective of market circumstances and scenarios. That said, when we talk about diversification in a bear market, we don’t mean stock diversification alone. Rather, what the bear markets call for is asset class diversification. In a bear market, merely diversifying your portfolio with stocks from multiple sectors and companies may not always yield good results.

Instead, you need to look beyond stocks and into other asset classes such as bonds, money market instruments, precious metals, and commodities, among others. By spreading your investment capital across multiple investment options and assets, you essentially bring down your total investment risk. Such a move can help you avoid huge losses that you may otherwise have to endure if you had put all your eggs in one basket, which in this case would be stocks.

2. Invest in fundamentally strong companies

Bear markets may be the perfect time to invest in fundamentally strong companies. The stock prices of companies that have strong financials, revenue streams, and net profit can still take a hit during a bear market. This is especially true if the bear market is fueled not through fundamental factors but by market sentiment. During a bear market, the stocks of fundamentally good companies also get battered and bruised along with stocks of companies that perform poorly.

This presents you with some good buying opportunities and allows you to pick up good stocks at very attractive valuations. And once the bearish trend reverses, the stocks of good companies generally tend to make a recovery, enabling you to realize some short-term gains. That said, here’s something that you should keep in mind. Always ensure that you conduct a thorough fundamental analysis exercise to determine fundamentally strong companies before you go ahead and invest your hard earned money.

3. Focus on defensive sectors and stocks

Stocks of companies that manufacture and provide essential goods and services are generally termed as defensive stocks. This is primarily because the demand for the goods and services manufactured by these companies are almost always stable irrespective of the prevailing market or economic scenario. Pharmaceutical companies, FMCG manufacturers, and utility providers are perfect examples of defensive companies, simply due to the fact that consumers are still going to continue to use their products regardless of whether the stock market is doing well or not.

And there’s enough evidence to suggest that even during bear markets, defensive stocks have a good history of performing well when compared to cyclical stocks. Furthermore, since they tend to generate a more stable revenue and net profit, defensive stocks are more likely to pay dividends to their shareholders even during the tough market phases. This makes defensive stocks one of the best bets for bear markets.

4. Short-sell stocks and indices

‘When in Rome, do as the Romans do’. You probably have heard of this age-old proverb, haven’t you? The same can be applied for bear markets as well. When you’re in a bear market, do what the bears would do, which is short-selling stocks and indices. Unlike buying stocks and then selling them, short-selling involves selling the stocks first and then buying them back at a later point in time. The gains that you get to earn from a short-sell transaction would be the difference between the selling price and the price at which you buy the stock back.

And since the stock prices are going to be plummeting during a bear market, you get the opportunity to benefit from downward price movements through a short-sell transaction. That said, here’s something that you should know. When it comes to short-selling stocks, you can only do so on an intraday basis. However, if you wish to short-sell stocks and indices for more than a day, you would have to do so using derivative contracts such as futures and options.

5. Utilize rupee-cost averaging and accumulate

Although this strategy might sound similar to the ones we’ve seen above, it is fundamentally different. The other strategies involve investing a lump sum amount into stocks, whereas this one involves investing a fixed sum of money at regular intervals. That makes it akin to a Systematic Investment Plan (SIP). All that you need to do is pick a few good stocks for your portfolio and invest a fixed sum of money therein, at the start of a bear market.

As the bear market continues its trajectory, the price of your stocks would continue to decline. Now, with every major decline, you would have to invest the same amount of money into your portfolio. As the price keeps getting lower, you get to purchase an increasing number of shares with the same amount of money. Over time, this would work towards bringing your cost of holdings down through rupee-cost averaging. And when the market trend turns bullish, you can then sell your holdings for a higher price.

Here’s an illustrative example of how this would work. We’ll take just one stock to make the details easier to understand.

Market

Month

Amount invested 

(INR)

Stock price 

(INR)

Number of shares bought

Bear

January

5,000

60

83

Bear

February

5,000

58

86

Bear

March

5,000

57

88

Bear

April

5,000

54

92

Bear

May

5,000

52

96

Bear

June

5,000

51

98

Bull

July

5,000

55

91

Bull

August

5,000

58

86

Total

 

40,000

 

720

So, at the turn of the market, the average price of each share in your portfolio would be just Rs. 55.55 (Rs. 40,000 ÷ 720 units).

6. Write a covered call

This strategy works only if you already possess the stock of a company. Writing a covered call is a stock options strategy, where you agree to sell the stock of the company that you own for a specified price (the strike price) at a future date. Now, when you write a covered call option at the start of a bear market, you effectively lock-in the price of the stock. And in turn, you also get to receive the call option premium from the option buyer.

There are two scenarios that are possible during the options expiry.

Scenario 1:

If the stock price is lower than the strike price, the option buyer wouldn’t enforce the contract, which would mean that you get to keep the option premium all to yourself along with the stock. 

Scenario 2:

Alternatively, if, at the options expiry, the stock price is higher than the strike price, the option buyer would enforce the contract instead. Here again, you get to keep the option premium and sell your stock at the agreed upon price.

This makes the covered call strategy a completely risk-free one with guaranteed gains. Again, let’s take up an illustrative example to understand this strategy.

Here are the particulars of the contract:

  • Strike price of the stock: Rs. 102
  • Options premium: Rs. 12

Scenario 1: At expiry

  • Stock price: Rs. 100
  • Strike price: Rs. 102
  • Option contract: Not exercised
  • Gain: Premium of Rs. 12

Scenario 2: At expiry

  • Stock price: Rs. 100
  • Strike price: Rs. 98
  • Option contract: Exercised
  • Loss from stock sale: Rs. 2 (Rs. 100 - Rs. 98)
  • Net gain: Rs. 10 (Premium of Rs. 12 minus loss of Rs. 2 from stock sale)

Wrapping up

With these investing strategies at your side, you don’t have to fear bear markets anymore. In fact, you can easily tackle them and convert them into opportunities to earn returns. In the next chapter, we’ll deal with exiting and holding strategies that you can use in a bear market. Till then, stay tuned! 

A quick recap

  • One way to invest in a bear market is portfolio diversification. We don’t mean stock diversification alone. Rather, what the bear markets call for is asset class diversification. 
  • Bear markets may also be the perfect time to invest in fundamentally strong companies. 
  • Defensive stocks also present good investment opportunities during bearish phases.
  • When you’re in a bear market, you can also do what the bears would do, which is short-selling stocks and indices. 
  • Alternatively, you can even utilize rupee-cost averaging and accumulate, or you could write a covered call.
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