Making Money During a Bear Market
Making Money During a Bear Market
A bear market is when the stock market has a prolonged selloff and stocks lose value, which is technically defined as a 20% or greater selloff in major stock market indexes. While it may seem counterintuitive, making money during a bear market is possible and is easier than ever, thanks to a variety of bear market trading products that have been introduced in recent years. Making money during a bear market is a form of short to medium term trading, not long term investing, and should be treated as a trading opportunity, not an investment.
Making Money During A Bear Market Is Possible
Over long periods of time, it is reasonable to assume that the stock market and the stocks that comprise the stock market will increase in value, as stock prices are driven by corporate earnings which in turn are driven by economic growth. Over time, the economy grows and stocks increase in value. However, economic growth can be very uneven and can even reverse and become an economic contraction, which is known as a recession. It is during times of recession and economic uncertainty that corporate earnings are reduced or called into question, and the stock market usually reacts negatively by undergoing a 10% correction or a prolonged 20% or greater bear market decline.
While it is futile to try to pick the top of a stock market rally, some reasonable assumptions can be made regarding the state of the economy. Economic expansions do not last forever and neither do stock market rallies associated with economic expansions. When recession clouds are looming and a stock market rally appears to be reaching overextended levels, buying bear market trading vehicles provides a way to hedge against a stock market downturn, and in the process potentially make money during a bear market.
How To Make Money During A Bear Market Using Trading Vehicles
There are a number of bear market trading vehicles that can be used to make money during a bear market. These trading vehicles include stocks, options, mutual funds, and exchange traded funds (ETFs).
The following bear market trades make sense either just before the economy enters a recession or during the first two months of a recession. If bear market trades are made too late into a recession, they may backfire and result in substantial losses, as the stock market usually turns around in anticipation of an economic recovery well before a recessional ends. Some of the bear market trading vehicles outlined below are more risky than others, so it is important to research them thoroughly before committing any money to a bear market trade.
Bear market trading vehicles that are on the conservative end of the trading spectrum:
- Buy Defensive Stocks – Certain sectors of the stock market either perform well or hold up well during bear markets. These include consumer staple stocks and utilities, because people still buy consumer products like paper towels during a recession and they still need to use utilities to provide electricity and heat for their homes.
- Buy Bear Market Mutual Funds or ETFs – Bear market mutual funds and ETFs are designed to increase in value when the stock market declines by making use of derivatives and short positions that go up during declining stock markets. Bear market mutual funds and ETFs are a good way to spread the risk associated with making a bear market trade amongst a variety of stocks and financial products. Some examples of Bear market mutual funds and ETFs include:
Bear Market Mutual Funds
- Federated Prudent Bear Fund A (BEARX) - BEARX is a mutual fund that mainly holds short positions in United States based stocks, indexes, futures, which increase in value during a stock market decline. At times, the fund has also been known to take small long positions in gold-mining stocks and some long positions in stocks the fund managers see as grossly undervalued.
- Grizzly Short (GRZZX) - GRZZX is a mutual fund that sells stocks short, which increase in value during a stock market decline. The fund usually holds approximately sixty to ninety stocks short.
Bear Market ETFs
- ProShares Short S&P500 (SH): SH is an ETF that attempts to replicate the inverse of the daily performance of the S&P 500 index. If the S&P 500 is down 2%, then SH should be up approximately 2%.
- ProShares UltraShort S&P500 (SDS): SDS is an ETF that attempts to replicate twice (two times) the inverse of the daily performance of the S&P 500 index. If the S&P 500 is down 2%, then SDS should be up approximately 4%.
- Direxion Daily Small Cap Bear 3X Shares (TZA): TZA is an ETF that attempts to replicate 300% (three times) the inverse of the daily performance of the Russell 2000 Index (which is an index that tracks small cap stocks). If the Russell 2000 is down 2%, then TZA should be up approximately 6%.
Bear market trading vehicles that are on the speculative end of the trading spectrum:
- Buy Put Options on Stock Market Indexes or Stocks – Buying put options on stock market indexes or stocks is a way of both hedging against a bear market selloff and potentially making money from a bear market selloff. Put options are a bet that stock market indexes or stocks will decline by a specific date in the future. Put options can expire worthless, if the stock market or stocks rise in value; and therefore the risks associated with buying put options should be well understood before buying put options (See: How to Trade Options).
- Short Stocks – Shorting stocks going into a recession induced bear market is especially effective with high flying stocks that are usually hit hard when the economy falls into recession. The bull market high flying stocks are often the same stocks that decline the fastest during a bear market selloff; however, be careful because they can rebound sharply when the stock market finds a bottom and starts to recover. Shorting stocks is risky and can result in unlimited losses, and therefore the risks associated with shorting stocks should be well understood before opening short positions on stocks.
- Buy An ETF That Derives Its Value From The Volatility Index (VIX) – Bear markets cause a spike in put and call options buying activity, which in turn causes a spike in the Volatility Index (VIX). Buying an ETF that mirrors the VIX can be profitable going into a bear market (See: How To Make Easy Money In The Stock Market).
- ProShares VIX Short-Term Futures ETF (VIXY): VIXY attempts to replicate the daily performance of the VIX. If the VIX is up 2%, VIXY should be up 2%.
- ProShares Ultra VIX Short-Term Fut ETF (UVXY): UVXY attempts to replicate the twice (2 times) daily performance of the VIX. If the VIX is up 2%, UVXY should be up 4%.
Please Note: Due to the nature of their investments, funds such as VIXY and UVXY that try to replicate the VIX on the long side will lose their value over time, if the VIX does not spike higher, and therefore these funds are only useful as short term trading vehicles and should never be used as a long term market hedge or investment.
- Sell Short An Inverse ETN That Derives Its Value From The Volatility Index (VIX) – An inverse exchange traded note (ETN) is an investment that plays the short side of its tracking assets. An ETN that is short the VIX will drop in value as the VIX increases in value.
- The VelocityShares Daily Inverse ETN (XIV): XIV attempts to replicate the inverse of the daily performance of the VIX. If the VIX is up 2%, XIV should be down 2%. Shorting XIV ahead of a bear market induced VIX spike is a way to profit from stock market volatility during a bear market selloff.
Making Money During A Bear Market | When To Close Out Positions
Establishing bear market trades as a way of making money in a bear market is relatively easy. It is important to understand when to get out of bear market trades to book bear market trading profits and to start looking at bull market trading ideas to try to make money from an eventual stock market recovery.
If history can be used as a guide, the stock market usually reaches a bottom sometime during the middle of a recession, and then starts to recover, as stock market participants start looking forward to an economic recovery. Keep in mind that stock market participants are forward looking, often looking out six to nine months, so while a recession is at its deepest, the stock market often starts looking forward to brighter economic days and starts to rally. Making money in a bear market is a matter of getting the timing of the bear market trade right.
Disclaimer: This article was not written by a financial professional or a registered financial advisor. This article is for informational purposes only, and is not intended to be solicitation or recommendation to purchase any financial products or securities mentioned herein. Please consult a registered financial advisor to ensure you understand the risks and rewards associated with buying and selling financial products and securities.
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