When the market takes a turn for the worse, it can feel like all opportunities to make money have disappeared. But in a typical bear market, smart investing can still lead to profits. In this guide, we’ll offer 3 strategies for how to make money in a bear market. Let’s get started.
What is a Bear Market?
A bear market occurs when the major stock indices – like the S&P 500 or the NASDAQ – fall more than 20% from their recent highs. Bear markets can occur in response to an economic recession or as a result of investor fear even when the economy is humming along.
It’s important to keep in mind that the 20% threshold for defining a bear market is arbitrary. The strategies we’ll describe for navigating a bear market apply equally well when the market is down 10%. In reality, bear market conditions can take hold anytime prices are falling and stock investors are generally acting more risk-averse than is typical.
How Long Does a Bear Market Last?
Bear markets can last anywhere from a few weeks to dozens of years. The last bear market, which occurred in February-March 2020 in response to the spread of COVID-19, lasted less than 4 weeks before the market began to recover. The financial crisis in 2007-2008, on the other hand, sparked a bear market that lasted for 17 months and erased half the value of the S&P 500.
In longer bear markets, there may be short periods of bullish activity within the overall bearish trend. It can be difficult to tell what price action is the beginning of a recovery and what is just a short-lived bounce until after the market has fully settled.
How to Make Money in a Bear Market
Bear markets pose a challenging environment for investors, who are typically focused on buying stocks in bullish conditions. However, you can use these 3 strategies to make money even when prices are falling.
Strategy #1: Weather the Storm
The first strategy for dealing with a bear market is simply to wait it out. Over the past 60 years, nearly half of bear markets have lasted less than a year, and only one has lasted more than two years. After each bear market, the major indices have not only recovered, but gone on bullish runs that left them higher than where they were before the downturn.
So, if you have a relatively long investment time horizon, holding onto your existing investments and continuing to buy into the market a little bit at a time can pay off. Rather than try to time the bottom of the bear market, use dollar-cost averaging to limit your total exposure to another downturn. It’s also a good idea to keep some cash in reserve for when the recovery gets into full swing.
Strategy #2: Look for Strength
Even in the worst of bear markets, it’s unlikely that prices are falling uniformly across the board. There are bound to be specific market sectors and individual stocks that are rising, even as the overall stock market falls. If you can find these investments, you’ll have an opportunity to earn returns that far outpace the market’s overall performance.
For example, the utilities sector typically rises in value during bearish conditions because consumers still need water and electricity no matter what the market is doing. The stability of these stocks makes them attractive to investors in turbulent times, pushing their prices up. Other defensive sectors that often rise in bearish market conditions are healthcare, telecommunications, and consumer staples.
One thing to keep in mind about investing in strong stocks and sectors during a bear market is that these assets usually suffer once the recovery gets underway. As investors become more risk-tolerant, they often pull money out of these stocks to reinvest in higher-growth areas. So, keep an eye out for signs of an impending recovery and ease your way out of these stocks as it nears.
Strategy #3: Go Short
The third way to profit in a bear market is to lean into it and short the market. There are a couple different ways to do this.
If you want to focus on individual companies that you think are poorly equipped to handle a bear market or a broader economic downturn, you can short-sell shares or buy put options. Keep in mind that in very bearish conditions, short-selling is likely to carry high margin rates and put options are likely to have steep premiums. Still, if you choose companies that fare worse than the overall market, these can be very profitable investments.
If you want to bet against the entire market or specific market sectors without singling out individual companies, you can invest in inverse ETFs. There are inverse ETFs for the S&P 500, the NASDAQ, the tech sector, the financial sector, and most other major sectors. Many inverse ETFs are leveraged, meaning that you’ll see a 2X or 3X return for every point the underlying index drops.
When investing in inverse ETFs, remember that these funds are meant to be held only for one day at a time. So, you’ll need to buy and sell inverse ETFs on a daily basis.
Conclusion: Making Money in a Bear Market
Investing in a bear market can be challenging, especially if the market is fresh off an extended period of rapid growth. However, it is possible to make money in a bear market with the right strategy. With these three approaches, you can profit from a bear market and emerge ready to take advantage of the eventual recovery.