Before we go deep into trading strategies for bearish market and how to trade the bear market effectively, let me share with you few famous quotations from the trading world.
“Traders make money when the price is going up, they make more money when the price is going down.”
“It takes huge effort and capital of investors to bring the stock at higher level but they fell with their own weight.”
“Stocks go up with the help of stairs but they come down on elevator.”
All these quotations throw light on the fact that it is inevitable for the market to go down and it is not only possible to make money in the bearish market but also it is the quickest way to make money in trading. Because the market goes down in a much higher speed than the market goes up. Before the beginner traders even have an idea, what is going on in the market, the market already covers a huge distance and made many seasoned investor millionaires. Many traders feel pain in such circumstances who have been taught that stocks only go up so buy the dip as they are facing the bear market for the first time.
Traders who are in the business of trading from the long time have faced many cycles of bull and bear market but who are new in the business must be conscious of it and learn two things.
1. You can make money in both, the bull and the bear market. Just learn how to trade them.
2. Stocks and any other financial instruments go up as well as go down. There is a possibility that you face bear market in every two years.
In this article, we are going to share few strategies that will not only help you to avoid losing money but also to be successful trader and make money in the bear market.
Tip # 1: Markets go Down in a Faster Speed than they go Up
If you have any idea about price action then you must have the understating of how the stocks behave both in the bull market and the bear market to trade successfully in the bearish market. Prices always go up slowly but they come down with the lightning speed.
The main reason of this behavior is the fear factor. When stocks come down, most of the traders got afraid and act faster as compared to when the act when the market is going up. Along with fear factor, there are some other critical factors as well to justify this behavior of the market and by understanding them you can avoid huge losses.
One of those factors is the leverage because when the market has on its peak, most of the traders have already utilized the highest leverage. When the stock is going up, most of the investors buy the stock over a period of time. They may buy it on more than once or twice and that ultimately increase their position size in that stock and hence the leverage as well. For example, if you have increased your position over a number of time then a single digit price down will end in greater losses. For example, if you purchase 1000 stocks at a price of 10 and you purchased another 1000 at the price of 20 and another thousand at a price of 30. Now the stock is trading at 40 and a one dollar decrease will result in loss of three thousand while the profit was 1000 when stock was traded at 10 dollars and you hold only 1000 shares. Most of the investors behave in the similar manners so they build up their position over a period of time and there is no leverage left in the market to further support the buying of the stock. When there are no buyers left then the market starts sell off. When the leverage is available in the market, traders tend to buy at dips that provide the stock the necessary buying pressure to move upward. If all the leverage of the market is over then investors will sell aggressively and you have to act fast and it is better to sell even when the price is going up otherwise you will bleed out. So, always keep an eye on your leverage as when it will be on higher side, you have to face higher losses.
Tip # 2: Volatility in Bear Market
As the market is moving toward its peak, there is very calm situation in the market. As the bear market starts, the volatility starts increasing as well and there is a situation of discomfort in the market. As investors surrender in front of bear market, the volatility got skyrocketed. Why this happens?
It is because many investors are on the peak of their leverage and a small change in price can affect their capital a lot in a negative way. This brings an urge of hurry and uneasiness in the market. The bigger stop losses are required to cover the swing points as the market waves are bigger. The buying dips are not sufficient to cover the bull rallies and these become only rallies sessions and not making the new highs. The traders who were calmly trading the daily market now have to face the big shots as the greater percentage change in the bear market is very common which is very unlikely in the bull market. In bear market as the market swings are high so you have to put your stop loses at a higher distance to set the logical stop loss. In such scenario, you can set your position size low to accommodate the distant stop losses. It may take many weeks in the bull market to cover the distance of more than 10% which may be a game of couple of days to move down 10% in bear market. So, whenever you see a quick bull rally in the bear market, don’t get confuse it with the market reversal and they may a 5% quick market correction if it has moved down 10% within few days. So, learn to trade big waves in the bear market.
Tip # 3: Risk Management in Bear Market
Managing your risk is a part of every market situation whether it is in the uptrend, consolidation or in the down trend. But in the bear market or in the down trend, controlling your risk is become more difficult due to distant stop losses and high volatility. In bear market, you have to decrease your position size to accommodate the distant stop losses and should have more patience to let the price hover around. You should have pre-decided risk management strategy and see how much risk you can take per trade or per month. If you loss 50% of your trading capital, you have to earn 100% to get back to break even. So, think before you lose. We do not recommend here to have a fixed % loss strategy rather you should place your stop losses logically and trade only those swing points which are providing better risk reward ratio. Decrease your trading frequency and increase your trading quality. Do not increase your position size on the next trade if you lose one for revenge trading. If you lose one then save your capital to live for another day. If you are getting uncomfortable because of some losses in a day then stop trading for sometimes. Have some vacations, go to a beach or park and come back to take a fresh start. As a thumb rule for risk management, we suggest that you should take risk of only less than 2% of your trading capital on a single trade.
Tip # 4: Be Bearish
You will see that in a bearish market, the organization will provide great profit earning statements, high dividend and future prospects as well. Positive news from the organizations and media will seduce you to take buy position. Brokers will tell you that it is high time to purchase the stock because it is in its lower value. But remember, what is looking lower usually goes lower. News are being intentionally installed to make up your mind. Do not take any trade with the influence of the quarterly result.
Now, think if everything that we are looking is positive then why the stock the going down. The answer is the market direction. Keep in mind that three out of four stocks will follow the market direction. If you have taken the right stock but in the opposite of market direction then there are higher chances that you will lose the trade. If you have mistakenly taken the wrong strong but in the right market direction then there are chances that you can win the trade. So, in the bearish market, all stocks will go down irrespective of their earning capacity and positive news flow. Also remember that bear market starts when market is looking entirely positive and there is positive news flow in the market because big investors want to sell at the peak that’s why they install such news to make the retails investor buy their positions.
In the larger bear market, the order flow is in the bearish side so irrespective of the sentiments, all stocks will go down. So, try to swim with the flow not against the waves. Apply your price action trading strategies here. Instead of buying the dips, try to sell the rips and trade bearish. If you see an opportunity for a very good buy trade and it looks that stock will go up, simply IGNORE IT. Consistency and higher win rate is compulsory to make money in the stock market and it is only possible if you only trade in the direction of the larger market.
The main points to remember of this article are
1. The bear market moves faster than that of bull market.
2. Keep a check on leverage, if there is low leverage left then it is probably the end of bull market.
3. If you have the maximum holdings and minimum cash in the trading account then it is expected that every other trader has the similar position. So, it is a high time to sell the market as the bear market is going to start soon.
4. Volatility increases in the bear market.
5. Do not buy the dips in the bear market. What seems lower usually goes lower.
6. Have proper risk management and we suggest and take only less than 2% of trading capital risk on every trade.
7. Trade only in the larger market direction. So, in the bear market take only short trades.