Making a fortune investing in stocks when markets soar is the easy part. The hard part is holding on to that stock investment when a bear market rears its ugly head. If you want to make an investment in stocks during these times, here are some tips on what you have to do with your portfolios.
Don't try to make money by shorting stocks
Unless you are very experienced or need urgent coverage, we should probably avoid shorting stocks. And if you are planning to sell shares short to compensate for the losses you have suffered during these months, it is definitely better to stick your arms to your chair and avoid going short at all costs. Making money from shorts may be the biggest challenge that both retail and professional investors face. This is because the price action is very different on the downside than on the upside.
Explanation of how short selling shares works. Source: IG
Diversify the risk in our investment in stocks狀
In a bear market, not all of our stock investment assets go down. In fact, defensive assets like bonds have historically provided attractive returns in environments where equity investing was down. It is true that some of those assets may be questioned amid the current context, but it is highly unlikely that all assets will fall at the same time, and certainly not for a prolonged period. If, for example, the Federal Reserve raises rates dramatically, the bonos They would be a poor hedge for our stock investment. Gold, however, should do well in that situation.
Diversification is a great ally for investing in stocks. Source: Napkin Finance
We must ensure that we have a diversified portfolio in different risk scenarios. Not only will we mitigate losses during a bear market, but we will also reduce the need to try to predict what macroeconomic environment will come next.
Don't try to time the floor of stock investing⏱️
We can sell our stock investment and wait for the storm to pass. So, how are we going to know when to return to investing in stocks? It's much, much easier said than done. So you shouldn't try it. Instead, a simple but powerful strategy is to spread our investment in stocks over time. Buying a regular amount at regular intervals (also known as dollar cost averaging) is a great way to buy more of an asset when prices are low and less when they are high.
Example of entries averaging entries in dollars. Source: Assignment Point
This effectively reduces our average entry price. This mechanical approach also has some other advantages. It guarantees that we will be invested when the market rises again, it reduces the risk of letting greed and fear guide us, and it is such a simple plan that it will eliminate a major source of worry.
Have a defined stock investment strategy
Buy and hold may be the best way to protect yourself during a bear market, but those who really want to profit will need to shift from a passive long-term approach to an active short-term approach. Active traders are always looking for their next move. From a currency pair that outperforms its fundamentals to a momentum strategy that is allocated to the strongest assets. These traders are constantly trying to identify the next market turn from which they can profit. But we must have an advantage, a clearly defined stock investment process and plenty of free time to analyze the stock investment sectors and implement their strategies.
Example of a scalping strategy. Source: CMC Markets
If you're willing to dive into more tactical approaches, professional investor Brent Donnelly's book The Art of Currency Trading is a book that tells about what it takes to be successful in short-term investing and what it will take for anyone who wants to be more tactical, regardless of the asset class they invest in.
Don't get carried away by greed螺
It's extremely difficult to know where we are in an economic cycle when we're in the middle of it, but the general greed and fear of the stock investment market usually provides a pretty good clue. In the late stage of bull cycles and the early stage of bear markets, greed tends to drive stock investing. In other words, investors invest in higher risk assets (such as investing in technology stocks, junk bonds and cryptocurrencies) and invest in increasingly complex financial products (such as SPAC).
Explanation of a SPAC. Source: Lugar-Investment Banking
In times like these, it is better to play more defensively, for example by having a more diversified portfolio, or having a larger allocation to defensive sectors such as investing in consumer staples or utility stocks. But after stock investment prices experience a big drop (historically 20% or more) and the media is overwhelmingly pessimistic, investors tend to panic and sell indiscriminately. This is when we have to start being greedy, rotating from defensive sectors and assets to more cyclical and economically sensitive ones.
Make our investment in “relative value” stocks
A decline in the stock market in general does not mean that we cannot make money by investing in stocks. One way to make money in bear markets is to implement “relative value” stock investing, where we go long one asset and short another. These long and short trades are considered “absolute returns” because they do not depend on the overall direction of the market, but rather on how one asset is doing relative to another. For example, both investment in consumer discretionary and consumer staples stocks decline when the broader market declines, but investment in consumer staples stocks, which are more defensive, generally decline less than consumer discretionary stocks. Therefore, by going long commodities and short discretionary, returns are driven by outperformance of one sector over another, not by the overall direction of the market.
Don't forget to make an investment plan in shares️
If we don't have a plan for when the markets hit bear market territory, creating one has to be a top priority. Even if you are a buy-and-hold investor, you may find it hard to do nothing when markets are down 70% and every media outlet is announcing the end of the global economy as we know it.
Our plan may be as simple as sticking a Post-it note that says “I will never, ever, under any circumstances sell” on our computer screen, but that's still a plan. And thinking about what we will or won't do in advance could be the difference between ruining our portfolios forever and putting them in the best position to capitalize on the eventual recovery.