Many investors end up losing their shirts in bear markets. It's unfortunate, but it's also avoidable. There are times when the markets are just plain lousy and surviving with most of our portfolio in tact is a victory unto itself.
There are dozens of ways to survive a market downturn, but keeping things simple is often the best course of action. We're going to look at what are perhaps the two best ways to survive and even thrive in a down market.
Learn to Love Falling Prices
One of the worst mistakes an investor can make is to think that he can only make money if prices are rising. Frankly, this is what most brokerage houses want you to think. Think about it. How many times has your broker called you with an idea that involves 'going short?' Probably never and as a result, most folks are programmed to believe that they can't make money in down markets.
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That's just plain wrong. Bad bear markets represent some of the best money making opportunities an investor will ever see. In fact, stock prices fall faster than they rise, so it's entirely possible that we can make the same money in a bear market that we would in a bull market, just in a shorter amount of time.
Best of all, there are more ways to profit from falling markets than ever before.
Decades ago, an investor had to short a stock to make money during downturns. Then the options market became more accessible to mainstream market participants, allowing regular investors to do things like buy puts and write calls to profit from bearish moves. Fast forward to the 21st century and the explosion in popularity of exchange-traded funds (ETFs). For every ETF that tracks a particular sector or index, there is likely to be an inverse ETF that gives investors bearish exposure.
The reality is a portfolio needs to be flexible and have the ability to profit during various market conditions. Yes, it's good to see stocks prices go up, but why shouldn't we make some money on the downside too? Any broker or financial advisor that doesn't make a client aware of ways to profit in a bear market isn't worth his salt.
Sometimes It's Just Time to Say Goodbye
Sometimes it can be hard to know when to sell an investment, and many investors seem to make matters worse by not knowing when to wave goodbye to their losers. There is no hard and fast rule for knowing when to bail on a loser. Some experts advocate selling when you're down a certain percentage. For example, they would say sell anything that you're 10% down on. This isn't necessarily a bad way of approaching your investments. It certainly helps to be disciplined and a 10% loss can easily turn into much more.
Another school of thought is more technical and would use price levels as a warning sign to exit a potential loser. Say you bought shares of XYZ for $42 in June and it went up for a few months. Here it is December and XYZ stock is hovering around $40 and if it breaks $40, the bottom could fall out. You would tell your broker that as soon as XYZ hits $39, you want out of your position. Again, this requires some discipline, but can save you a lot of pain in the long run.
Regardless of the method you use to get the sell signal, know before you buy that stocks and other securities frequently advertise that it's time to get out. For example, holding XYZ from $60 to $40 isn't a good idea. Why? Because that's a loss of more than 30% and the pain may not end there. This stock, with its large decline, is saying it's time to bail. There's something broken and we can't fix it. Remember, stocks sometimes won't stop falling until they get to zero!
The Investing Answer: As we said earlier, a list of survival tips for a market downturn could be far more expansive than what we've discussed here. Ultimately, all an investors needs to know to survive a bear market is that steep losses must be avoided and there are ways to turn a bad market into a possibility for profit.