A bear market is traditionally defined as a period of negative returns in the broader market where prices fall 20 percent or more from recent highs. During this type of market, most stocks see their share prices fall at least that far. There are several strategies that are used when investors believe that this market is about to occur or is occurring, which depend on the investor’s risk tolerance, investment time horizon and objectives.
One of the safest strategies, and the most extreme, is to sell all of your investments and either hold cash or invest the proceeds into much more stable financial instruments, such as short-term government bonds. By doing this, an investor can reduce his or her exposure to the stock market and minimize the effects of a bear market. That said, most, if not all investors, have no ability to time the market with accuracy. Selling everything, also known as capitulation, can cause an investor to miss the rebound and lose out on the upside.
For investors looking to maintain positions in the stock market, a defensive strategy is usually taken. This type of strategy involves investing in larger companies with strong balance sheets and a long operational history, which are considered to be defensive stocks. The reason for this is that these larger more stable companies tend to be less affected by an overall downturn in the economy or stock market, making their share prices less susceptible to a larger fall. With strong financial positions, including a large cash position to meet ongoing operational expenses, these companies are more likely to survive downturns. These also include companies that service the needs of businesses and consumers, such as food businesses (people still eat even when the economy is in a downturn). On the other hand, it is the riskier companies, such as small growth companies, that are typically avoided because they are less likely to have the financial security that is required to survive downturns.
These are just two of the more common strategies and there is a wide range of other strategies tailored to a bear market. The most important thing is to understand that a bear market is a very difficult one for long investors because most stocks fall over the period, and most strategies can only limit the amount of downside exposure, not eliminate it.
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A bear market can be an opportunity to buy more stocks at cheaper prices. The best way to invest is a strategy called dollar-cost averaging: You invest a small, fixed amount, say $1,000, in the stock market every month regardless of how bleak the headlines are. Invest in stocks that have value and that also pay dividends; since dividends account for a big part of gains from equities, having them makes the bear markets shorter and less painful to weather. Diversifying your portfolio to include alternative investments whose performance is non-correlated with (that is, contrary to) stock and bond markets is valuable, too.
Finally, It is important to have a financial advisor to “hold your hand” during market downturns, preventing you from selling out at the wrong time based on fear or emotion.