How to make money in a bear market
Reading time: 7-10 minutes (1.898 words)
Seeing red numbers may seem like a bad thing for investors. And it certainly is if you bought in at the wrong time. For example, Tesla dropped almost 50% in just a few months:
If you bought Tesla shares at $1200, bad times may be ahead. With all the things going on in the world right now:
- High inflation
- Increased interest rates
- War in Ukraine causing high oil and commodity prices
Prices won’t go up to $1200 anytime soon. Most car companies are struggling to sell new cars because of computer chip shortages.
But let’s assume you did not join the hype and bought Tesla shares at a more reasonable price of $750. Assuming you looked at the financials of the company and future outlooks, would you now buy more shares or sell your existing shares? It does not make much sense if you were willing to buy Tesla for $750 but not for $600 right?
Did the fundamentals of the company change?
First thing to note is that fundamentals of a company do not change when a global event is causing a bear market. It’s still the same company, only people are scared to lose money and pull out their investments. When inflation is high, people can spend less money and companies earn less money. When interest rates go up, companies can lend less money to expand their business. All these things can cause stock prices to go down. But did the fundamentals of the company change? That is the key question.
When covid hit, it was pretty clear airliners would face bad times. It was also pretty clear that pharmaceuticals selling vaccines would thrive. The fundamentals changed because the specific market for those companies changed. Airliners still have planes but there is way less demand for flying when there is a virus in the air killing people. While pharmaceuticals suddenly see a huge demand for vaccines. The main reason to be the first company to have working vaccine was not because they want to save people but to be the first in the multi billion dollar market. How else can you explain that only 18% of the people in financially poor Africa is fully vaccinated? Afrika did not have the money to buy the vaccines. They sold all their vaccines to the highest bidders in western countries first. And from a business standpoint that totally makes sense.
The market did not really change for Tesla. People still want to buy their cars but Tesla is having trouble delivering new cars due to computer chip shortages. Meanwhile, inflation is high so many people have less money to spend. They will drive their current car for a few years or will look for one on the second hand market. That does not mean Tesla is making bad cars all of the sudden. The market simply has less demand and supply is having trouble delivering.
If the fundamentals of Tesla did not change, should you buy more shares? First you should determine if the current price is a reasonable price. Maybe Tesla was overpriced the last few years and maybe the current price is actually reasonable. Considering the FED pumped 2.3 trillion dollars in the economy even before covid happened. If you determined that the current price is reasonable, an upcoming bear market is the perfect entry to buy more Tesla shares. Simple because you can buy more shares for cheaper prices.
What strategy would be best in a bear market?
One thing that is impossible to do (many traders try) is finding the bottom of a market. And the same thing is true for finding the highs. Nobody knows. Don’t try to time the bottom or think how high something will go. You are wrong 99% of the time. The only thing you know when a bear market hits is that prices will go down. This might last for a few months, a few years and sometimes decades.
Another thing to note is there are fundamental differences between index funds and individual stocks. The fact is, in the history of the stock market, the price of indexes only went up in the long term. Sure, there were some bear markets but there were many more bull markets. Just look at the history of the S&P 500:
Basically this chart tells you to never sell! And it makes sense that the stock market only goes up in the long term. Because we humans are always striving for the next new thing. New companies rise, new inventions emerge, new ideas, space travel etc. The human mind is never quiet and is always desiring more. We evolve.
You should be wary of two important things here:
- The above chart is from an index, not individual companies
- The past is no guarantee for the future
While buying and never selling might turn out pretty well for index funds, it does not mean you can just hold any company and never sell. The S&P 500 is a dynamic index consisting of the 500 biggest companies in the U.S. based on market cap. If one company goes bankrupt and falls out of the index, another company takes its spot. Because there are 500 companies in the index, it does not matter if one or more goes bankrupt. Businesses fall out of the S&P 500 all the time.
It’s practically impossible for the S&P 500 to drop to zero. That would mean literally every company is bankrupt. But individual companies can go down all the way to zero and you’ll lose all your money. That’s why ETFs and other index funds are very popular. You already diversified into 500 companies from many different industries in the case of the S&P 500. The risk the index drops to zero is practically zero. The only downside is you only get average returns.
Investing money each month regardless of the price is called dollar cost averaging. That means in bull markets you’ll pay premium prices but in bear markets you’ll buy with discount. You always buy in at the best average price.
You can approach this in multiple ways:
- Buy in with the same amount of money each month
- Buy in below former support and resistance zones and buy more with each step
For example, the bitcoin market looks like this:
The white horizontal line is drawn over former resistance levels and now acts as a big support level. Not only because it was a former resistance level but also because $20,000 is a very psychological price level. When we look at former drops in the market we can see some similarities:
Each time the price dropped it was about 55% from top till the bottom. We are now at exactly that same spot. And that also happens to be the former resistance level and a psychological price point. If we apply dollar cost averaging, then there is no need to worry if the price drops below $20,000. Price might drop down all the way to $12,000. But if you buy a little bit every month, your average price will be a lot more gentle.
If we take the second approach (buying more with each step), you can start nibbling in below $20,000. Buy a small amount at $18,000 and continue to buy more each time the price goes down with $2,000. So you buy some bitcoin at $16,000, some more at $14,000, even more at $12,000 and if you think $10,000 is the lowest it will go then put your biggest buy order there.
The main difference between both strategies is that with dollar cost averaging you are targeting larger time frames. For example, you buy in each month. It's best to not make too many transactions as with each transaction you have to pay transaction costs. With the other strategy you are placing limit buy orders instead of market orders. Meaning they can potentially all be filled within one day.
- With a market order, you are buying or selling at the current market price
- With a limit order, you determine for what price you are buying or selling. Whether the order will be filled depends on the order book.
After that you can decide to sell if the price goes up and take profit or become a long term investor and hold for the next ten years. That totally depends on your view, financial state and other requirements.
These strategies can also be applied to index funds or ETFs. An ETF tracking the S&P 500 will never drop to zero. If you just put down orders all the way down you’ll always buy in at a good price. You can also do the same thing for your favourite company. But the chance that a single company drops down to zero is much greater vs index funds.
So be aware that buying individual companies this way is much more riskier. In that case the strategy only works if the company is healthy and has a healthy future. For example, airliners did very bad last few years. And covid is still here so air traffic won’t reach all time highs any time soon. Also, don’t forget the large amounts of debts these companies accumulated because planes were grounded. Air France -KLM quadrupled shares in June 2022 in order to pay off debts.
So in short:
- Find out if the company or index fund is trading at a reasonable price using fundamental analysis (for companies, look at balance sheets and income statements).
I can help you with that. Find the ticker for the company you are interested in (for example, TSLA) and hit search at the top of this screen. You’ll then get a very detailed overview of all the information you need. Have a look at TSLA. You can even add or change the metrics I used to determine the overall health of the company.
- Use technical analysis to find support, resistance and the current trend. For example:
Each large drop in crypto measured around 50%. The former top from 2019 at $20,000 now acts as resistance (white line). Also, $20,000 is a psychological price level.
- Use dollar cost averaging or buy the dip to buy below supported price levels to benefit the most.
In the case of bitcoin that would mean buying in when the price drops below $18.000 or lower (depending on how low the price you think will go). As of right now (20/06/2022), bitcoin already dropped to $17,500 and price bounced back to $20,500. That’s 15% profit. Or, if you are in for the long term you can just hold and maybe bitcoin reaches $100,000 in five or ten years. Don’t forget it already reached $70,000 just one year ago.