The COVID-19 market crash was unprecedented in more ways than one…
Historically, the average bear market for the S&P 500 lasts a little less than 18 months and occurs about once every six years.
So the bear market that began in 2020 was the fastest – and shortest – in history. It took just 16 days for the S&P 500 to fall more than 20%, crossing officially into bear market territory… Meanwhile, the total bear market lasted just 33 days.
And the ensuing rally to record highs over the past 15 months has put many investors on edge.
If that’s you, don’t worry. You can make money by sticking to a few simple rules – even if conditions appear ripe for another bear market…
Stock valuations are the highest they’ve been since the dot-com bubble. The Shiller P/E Ratio, a measurement of the average price-to-earnings ratio of S&P 500 stocks, sits at around 38 today. That figure is higher than Black Monday in 1987 and Black Tuesday in 1929.
This is just one warning signal that we could be due for a fall in stocks. The chart below shows that the Shiller P/E ratio is heading into territory not seen in more than 20 years…
Whether the next bear market comes in two weeks or two years, it’s essential to be prepared.
That’s what we’re discussing today… how to succeed in a bear market. Let’s look at the five bear market rules that you need to know right now…
No. 1: Don’t Become a Day Trader
As bear markets occur, the worst possible strategy is to turn into a day trader.
Day traders attempt to make money by quickly jumping in and out of stocks. These trades can last a day, an hour, or even a matter of minutes.
Jumping in and out of stocks based on recent moves will likely fuel a losing streak. If you haven’t been day trading in the past, a bear market is not the time to start.
Roughly 80% to 90% of new day traders fail in their first year, depending on which source you cite. Even worse, about 80% of day traders will quit in their first two years, according to Tradeciety.com.
Day trading is very emotional for new participants. And trading on your emotions is not in your best interest.
If you’re serious about making money in the market, it’s critical to shift your attention away from day-to-day movements… and even month-to-month movements.
That brings us to our next rule…
No. 2: Maintain a Long-Term Focus
Back in March 2020, the days felt longer when investors watched their portfolios stretch deeper and deeper into the red. During those stressful periods, it’s tough to remember that all bear markets have one thing in common: They all end.
Again, according to the Schwab Center for Financial Research, the average bear market for the S&P 500 tends to last a little less than 18 months.
If you recall the 2008 to 2009 financial crisis, the people who bought at market lows could do so because they had available cash on hand. By purchasing index funds and strong companies, investors could build a portfolio on the cheap.
Six years later, patient investors made huge profits. This is especially true for those who used all the tools at their disposal to increase their exposure to long-term investing.
Bear markets are a good reminder to use company 401(k) matching programs and be patient to wait for a rebound. Those who did were handsomely rewarded in 2009 and 2020. Investors who follow that same game plan will find success in the next bear market.
No. 3: Cut Your Margins
One of the biggest mistakes investors make is that they fail to slash their margin accounts when the markets start to fall. When investors use margin, they are effectively borrowing money from their brokerage to invest. They can enjoy the gains from this money, but they are on the hook for everything if the investments decline.
Brokerages can force you to sell your stocks or other falling investments during a process known as a “margin call.” These margin calls typically happen when prices have cratered. There’s no negotiation during a margin call, and it can cost you a lot of money if things go sideways.
Let’s say that you have $100,000 in cash in your account that you use to buy stock… and you have another $100,000 in margin on your account. If we see a 25% pullback during a bear market, a decline could cost upwards of 50% of your initial cash investment. The reason is that the margin capital is not your money. So, the brokerage can reclaim its capital and force you to settle from your original cash investment.
No. 4: Separate the Signal From the Noise
One of the biggest disadvantages that investors had over the past 100 years is information inequality. What I mean is that institutions had more insight into events that were about to happen than retail investors. But a combination of regulatory understanding and technological progress has helped to level the playing field.
Now, more people are able to get an idea of when a bear market is about to occur… and when retail investors should move to cash.
In the case of regulatory filings, pay close attention to corporate insiders’ buying and selling habits. CEOs and chief financial officers are two of the most reliable sources of knowledge about a company’s short-term and long-term future.
If corporate insiders are selling – and I mean a lot of them all at once – this can signal that Corporate America expects a sharp downturn in the market. In February 2020, we saw insider selling hit nosebleed levels as the markets prepared for a possible shutdown of the economy.
On the flip side, corporate buying can be a sign that a recovery is in play. A wave of insider buying transpired when the Federal Reserve said it would provide full support to the markets after the COVID-19 crash.
No. 5: Make Extra Money on Your Long-Term Positions
I’ve explained the value of a long-term mindset in stocks. Investors who build positions during a bear market can achieve incredible gains during a market recovery. And you can use many different strategies to make money off existing long-term positions.
For example, if you’re determined to be a long-term owner of Apple (AAPL) and you own 100 shares, there are simple, conservative, low-risk strategies to generate income off these positions. One example is known as a “covered call.” In this situation, you sell a contract that gives a potential buyer the right, but not the obligation, to purchase stock from you if it goes higher and reaches the “strike price.”
There are many other ways to generate additional cash during a bear market. Best of all, you can use the cash to buy some of your favorite stocks on the cheap.
These rules can help you prepare for the next bear market… and they can also help you find that next great opportunity when the downturn arrives.
Regards,
— Keith Kaplan
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Source: Daily Wealth