A bear market is coming. As the stock market continues to move higher, we are getting closer and closer to a major pullback. And when I say major pullback, I am not talking about a 5% or 10% drop. I am talking the same kind of drop we saw back in 2008.
Why? Remember back then when housing prices were hitting record highs each month? Everyone was buying thinking prices will never go down? It was shortly after this point when the bubble burst, home values tanked, and millions lost their homes.
Now look at the stock market today. The Dow Jones started the year under 20,000. It is currently over 24,000. Never in the history of the stock market has it surpassed 5 thousand point thresholds before. And some experts think we will hit 25,000 before the end of the year.
Many people I talk with are getting in thinking that stocks will never be cheaper. Sound familiar?
A bear market is coming. This post is going to walk you through how to prepare and protect yourself.
What Is A Bear Market?
For some newer investors reading this post, you might be unfamiliar with the term bear market. A bear market is when the stock market declines by at least 20% over the period of two months or more. The difference between a bear market and a correction is that a correction is a quick hit.
Most corrections happen over a period of a few days. A bear market lasts at least two months. On average, the length of a bear market is 15 months or just over a year.
When we enter a bear market, prices fall and investors become pessimistic about future growth. This emotional feeling is self-serving as more and more investors sell, forcing stocks lower. A better strategy is to buy and hold Motley Fool stock.
How To Protect Yourself Before A Bear Market
Before a bear market hits, you should be putting any money you were going to invest into cash holdings. This includes savings accounts and money market accounts. While you won’t earn much interest doing this, you will protect yourself from losses.
It is not uncommon during a bear market for cash positions to make up 10% or more of a portfolio. After all, why put the money into a market that is only dropping in value?
Another option to protect yourself is to look through your portfolio and place stop-loss orders on some holdings. This will trigger a sell if the security drops in value to a price you no longer want to own it at. This helps to reduce downside risk and limits your losses.
How To Make Money During A Bear Market
While stock prices are dropping, you probably think that everyone is losing money. But you are wrong. A lot of money is made during a bear market. How is this possible?
One technique traders use to short selling. When you sell a security short, you are selling a borrowed security hoping to make money on falling prices. For example, let’s say a stock is trading at $100 per share and you want to short 100 shares.
You borrow 100 shares from your broker and cover (meaning you agree to buy the shares) at $85 per share. The price of the stock drops to $85, triggering the cover. You buy the shares at $85, making $1,500.
What happened here is you borrowed 100 shares and sold them, making you short the stock. When the stock price dropped, you closed your position and bought 100 shares. The result is that you ended up making $1,500.
Another way to make money during a bear market is to buy inverse ETFs. These investments work opposite of what the market is doing. For example, if the market drops the fund would rise in value. If the market were to rise, the fund loses money.
There are many inverse ETFs out there to invest in. You just have to find the one that meets your needs.
A bear market can be a scary time for investors. As prices fall, you see the value of your investments drop in value and begin to question whether you can still afford to retire. But it doesn’t have to be this way.
You can be proactive and protect your investments during a downturn. And one is coming. As I mentioned, this is a historic bull run in terms of point gains. It also is historic in length of time. 2018 will be an interesting year to see whether the bull has any steam left.
My thinking is that the market will rise early in the year thanks to strong holiday retail sales but then cool off by the middle of the year. After that, the market will begin to sink and before you know it, the bear market will be here.