If you follow financial news, you might have heard of bear and bull markets.
These are terms used to describe how the stock market is doing in terms of the upward or downward trajectory of value. You might be wondering why these are named in this curious way. Let’s look at some of the basic facts.
Bear and bull markets are named after the fighting styles of bears and bulls. When a bull attacks, it strikes with its horns from top to bottom. So, metaphorically speaking, when a bull market strikes, the prices of stocks generally tend to go up rapidly.
The imagery of bull and bear is sort of like the yin and yang of the investing world. In the sense that one cannot exist without the other.
If the price of stocks rise rapidly, they are bound to come down, and conversely, if the market is seeing a deep slump, it is bound to go up. So the market always exists in flux between bull and bear states.
Simply put, a bear market occurs when there are more sellers than buyers. An oft-cited instance of a Bear Market is the recession which led the Wall Street stock market crash of 1929.
At the time, because of consistent losses, investors were trying to exit the market. To prevent excessive losses, investors continued selling their stocks causing a further decline and market collapsed, followed by a sustained depression in the economy called as the ‘Great Depression’.
Technically speaking, a bear market is used to refer to a period of negative returns in the broader market where prices fall 20 percent or more from recent highs.
This is a steep drop and for long term investors, bear markets can be brutal. But, bear markets often tend to be shorter than bull markets and less intense, so with a combination of patience and smart investing, one can still minimize losses during a bear market.
Let’s look at some of the most common strategies used by investors:
As the old adage goes, when times are tough, the tough get going.
This is the case with companies during market crashes as well. Companies that are well established, with strong balance sheets and a long operational history tend to lose less money in the market, so your best bet if you want to hold onto your money is to load up on these stocks.
This is called a defensive strategy.
With strong financial positions, including a large cash position to meet ongoing operational expenses, these companies are more likely to survive downturns.
These also include companies that service the needs of businesses and consumers, such as food businesses. Whether the economy is going up or down, people will always need to eat, so this is a sound investment to make. The same also applies to healthcare, grocery stores and utilities.
Diversifying your portfolio is always a solid investment strategy: bear market or not. This entails investing in a mix of different assets, including stocks, bonds and index funds.
Why does this always work? The answer is very simple.
During a bear market, usually, all stocks fall, but some less than others. Diversifying your portfolio helps you invest in a mix of winners and losers.
So, if you make a risky investment here, you can balance it out with a safe bet elsewhere. So, during the bear market, these losses of average each other out, ensuring that you’re not losing too much money.
But here’s the thing: it’s not always easy to predict the winners and losers in advance. So, what do you do? Here, defensive stocks are your friend. Make sure you have some money tucked away in the safe stocks ( healthcare, grocery stores, utilities, food) so that it may be of use during a market crash.
Dollar Cost averaging is a technique you use, to invest regularly in the equity market in small amounts.
Dollar Cost Averaging can be especially useful during bear markets because it’s designed to average out losses. A lot of times, investors in the stock market can be emotional and make big investments on a whim, and these often translate into disaster when the bear market strikes.
Because everybody will be in a hurry to get rid of these stocks or mutual funds.
A lot of times, when the stock prices start falling, investors might see an opportunity to buy more of a stock that they strongly believe in.
This is an emotional decision, often dictated by a gut feeling.
For example, if you buy a bunch of stock for 50 rupees each, and then at some point, as the bear market hits, the price comes down to 30 rupees, you may be tempted to buy up more of this stock because you strongly believe that the price will not fall beyond this point and will inevitably go up.
This is a risky decision because bear markets crashes are unpredictable and the price may even tumble to say, 5 rupees, leaving you with a number of low performing stocks that you can’t get rid of. This approach of predicting the bottom price of a stock is highly inefficient.
Dollar cost averaging is a much more efficient way to invest in the market. For example, suppose you have 10,000 rupees to invest. If you spend all the money at once, say, when the stock price is at 20 rupees, you will have 500 shares.
Let’s take two scenarios. Now if the price goes down to 10, and you decide to sell, you make a loss of 5000 rupees. Conversely, if the price goes up to 30, you make a profit of 5000 rupees.
Let’s say instead of spending the 10,000 rupees as a lump sum amount, you spend it in four installments, spaced out across the year. Let’s also assume that it’s a falling market.
Say, the first time the stock price is 20 rupees, the second time the price is 15, the third time the price is 10, and the fourth time the price is 5. This would fetch you 1041.6 stocks, which is substantially more than the number of stocks you would get if it had been a lumpsum purchase.
Now, let’s say the stock price goes up to 30 rupees again, you could make a bumper profit of 21.2 thousand rupees! And suppose the price doesn’t improve and bottoms out at 10, the loss you make would still be only 416 rupees. In other words, dollar cost averaging is a great way to maximize your profit and minimize your losses!
Bear markets can be tough to handle, but with a little bit of smartness and patience, you can overcome it. So, if you’re an investor who tends to make emotional decisions, it’s time to take them out of the game and diversify your portfolio!
Disclaimer: The views expressed in this post are that of the author and not those of Groww