The stock market has proven to be resilient over the years, but like life itself, it’s subject to ups and downs. Some financial experts predict difficult times in the coming months.
This tends to generate anxiety about the beginning of a “bear market” — loosely defined as a period when prices in the stock market fall by 20% or more, according to certain indexes. Bear markets are seen as times when the opportunity to make money through investments is limited (if it even exists at all).
But it’s not necessarily all doom and gloom. In this post, Gorilla Trades examines how to make money in a downward market using a few creative strategies.
Buy Dividend Stocks with High Yields
Companies that issue dividend stocks send their shareholders a portion of their earned revenue, usually once a quarter. Those with high-yield dividends can bring at least a little income during tough times.
This is the case even if the company’s share price is low. The dividend comes out of earnings, which the best companies regularly generate no matter how low their shares are priced.
At the end of the day, the stock market sets share prices — they’re merely a reflection of stock market activity and speculation. Revenue is cold hard cash, so dividends are reliable income sources.
High-yield dividend stocks are almost always issued from stable, established companies with dependable earnings year after year — household names like 3M, Chevron, Lockheed Martin, and some companies you may not have heard of but do a lot of business. Having a few of them in your portfolio can help you make money in bear markets.
Buy Defensively
No matter how terrible market conditions are, consumers are always going to buy certain products and services. Everybody needs staples like food, pharmaceuticals, soft drinks, toilet paper, clothing, delivery services, and so forth.
Even in a bear market or a recessed economy, someone’s going to buy something. They’ll just be doing it less often.
So, it’s never a bad idea to have a few stocks that have a fairly consistent revenue floor in bear markets — those that serve basic needs that everybody has. They serve as defensive reinforcements against commodities that don’t do well in weak economic times, like cars, technology, hotels, or real estate.
Consumer staple stocks will probably go through a few ups and downs themselves, but not as severely as those industries. At the very least, they can limit losses during extended weak periods.
Look for Companies with Good Bond or Credit Ratings
One of the more reliable, if unexciting, trading strategies in a bear market is to invest in companies that are in good overall shape. Every stock is subject to declines when bear markets hit, but some companies are better at getting back above water than others.
A good way to find those companies is by searching for those with high bond ratings. Businesses use credit the same way people use credit cards. Those that keep a solid credit rating — between A and AAA — are generally considered to be more stable because they cover their debts responsibly. A company with a credit rating of B or lower is perceived as a riskier investment.
So, when bear markets hit and every company feels the burn, having a bedrock of highly-rated companies can at least soften the blow. Check with agencies like Moody’s and Standard & Poor’s to find a company’s credit ratings.
Short Selling
Short selling is one of the more popular bear market strategies but also one of the riskiest. If you’re an accomplished investor with a strong stomach, short selling might be worth a try when the market’s in decline.
In short selling, an investor “borrows” shares, believing and/or hoping that their price will go down. They immediately sell the shares on margin, pocket the profit, and then buy them back at a specified date when the price has hopefully gone down. They then return the shares to the party that lent them out.
Who would lend shares for shorting in the first place? Your brokerage, if it’s something they do. Typically, the brokerage will take shares from one client’s portfolio and replace them with other shares from their inventory. The brokerage charges commission and interest fees on short-selling transactions, so the risk to the brokerage is at least a little mitigated.
For the short seller, that risk is far more pronounced. If the price doesn’t go down, the investor gets stuck having to buy back the shares at the higher price, wiping out their profits. That’s why short-selling should only be done by investors who know their business inside out. But if it’s done right, it’s one way to survive investing in a bear market.
Put Options
Similar to short-selling, put options are vehicles investors use when they expect a certain commodity’s share price to go down. In a put option, the investor retains the right to sell their shares at a certain point. This is known as the strike price. The investor is not required to sell the shares — that’s why we call it an option. But they can if they want to.
When the share price reaches the strike point and continues to decline, the investor can sell it at the agreed-upon strike price or they can resell the put option itself. Either way, they can pocket a tiny profit.
But also like short-selling, if the investor misjudges and the share price goes up, the put option loses its value. Again, it’s a method recommended only for experienced investors who don’t have vertigo.
Buying Call Options
A call option is basically the reverse of a put option. In this strategy, an investor reserves the right to buy shares in a commodity when they reach a certain low point. The hope is that the price will go up in a relatively short time and the investor can sell their shares for the margin. Again, since we’re talking about options, the investor isn’t obligated to buy the shares.
There’s some risk with call options that the share price won’t increase if the buy option is executed. It’s not as dangerous as put options since call options are by nature usually not very expensive to begin with. However, remember that call options are 100% speculation, not an investment strategy.
Be mindful of the expiration date on a call option. You’re essentially timing the market, which a lot of fearful experts recommend strongly against. So don’t let that date slip past you if you do.
Write Covered Call Options
This variation on options is an almost risk-free strategy to make money in bear markets. In a covered call, you sell a call option against a stock that’s already in your portfolio — which means that when the stock hits a certain price, you’re obligated to sell it to another party.
You keep the profits, also known as the “option premium,” if the stock exceeds the strike price. If it doesn’t, you maintain possession of the shares and the profit you made from selling the option.
The only drawback to a covered call option is that you may be required to sell your stock before it goes even higher in share price, so you can’t take advantage of those post-option gains. But you may not miss those much anyway, especially if you do covered call options often enough that you have consistent income.
Gorilla Trades: How to Invest in a Bear Market
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