Three Critical ‘Rules’ for Bear-Market Investing

Dec 10, 2021

Over the past few weeks, I’ve been doing my best to help Money Talks readers prepare for the next bear market in stocks.

We’ve covered a lot so far.

I’ve explained why the next bear market could be more severe than most folks believe possible… I’ve shared the simple steps I think every investor should take now before any selling begins… and I’ve explained why cash is the most important asset you can own in a bear market and showed you how to make sure it’s available when you need it.

But if you’ve only taken away one idea from this series to date, I hope it’s this:

Successfully navigating a bear market is far more about playing good defense than playing good offense.

Your primary goal in a bear market is simply to get through it with as much of your hard-earned capital intact as possible. If you can merely hold on to what you already have, you’ll be better off than 99% of investors.

But this is only half of the equation.

Ideally, you also want to be able to use that capital to take advantage of the enormous opportunities that bear markets can create. This is where life-changing wealth can be made.

So, over the final two weeks of this series, I’m going to show you some ways to do just that.

I’ll share a few general “rules” for bear-market investing this week. And next time, I’ll share some specific bear-market strategies you might consider adding to your investment tool kit in advance.

All right, let’s get to it.

Bear Market Rule No. 1: Don’t try to “catch a falling knife”

Patience and discipline are always valuable traits for investors. But they’re critical in bear markets.

One of the most common mistakes investors make during big market declines is buying a stock in a strong downtrend. (Wall Street calls this trying to “catch a falling knife.”)

Folks see a favorite stock of theirs down 20% to 30% or more and can’t resist the urge to buy a large position while it’s “on sale.”

This strategy can work in a bull market. But it can spell disaster in a bear. More often than not, these folks will then watch in horror as shares keep falling and falling farther than they ever dreamed possible.

To be clear, there’s nothing wrong with wanting to buy great stocks at bargain prices. That’s the greatest opportunity bear markets offer. But you’ll save yourself a ton of stress and money if you wait for signs of a bottom first.

Here at TradeSmith, that means waiting for a stock to return to the Health Indicator Green Zone before buying, at a minimum. More conservative investors may also prefer to wait for the overall market to trigger a new bullish signal before buying any stocks.

If you’re not a TradeSmith subscriber, even basic trend-line analysis can work.

The key idea is, you want to see some indication of an uptrend or positive momentum before buying. Sure, you may pay a little more by waiting, but your odds of success will be much higher.

This leads to my second rule…

Bear Market Rule No. 2: Don’t be afraid to sell or take profits

In recent years, investors have become accustomed to relatively brief, v-shaped corrections. And the March 2020 crash was a prime example.

Most stocks plunged nearly straight down through February and March, spent just a few days or less at the lows, and then reversed higher.

Major indexes like the S&P 500 and the Nasdaq 100 started triggering new bullish signals almost immediately and have remained in the Green Zone ever since.

Anyone who bought stocks at that time is likely still holding many of them today. And they probably realized some nice profits on those that were already stopped out.

But not all bear markets are so simple.

Most tend to “test” — to revisit or slightly exceed — their ultimate lows at least once or twice, whipsawing both bulls and bears alike.

After their steep initial declines, they can often be long, grinding affairs with weeks or even months of false breakouts.

And in the most extreme cases, they can even go on for years, alternating back and forth between mini-bull and mini-bear markets that go nowhere for a decade or more.

So, if you hope to catch “the” bottom, you must be prepared for the real possibility that you could be stopped out multiple times before you do.

That would be frustrating (though depending on the path the market takes, those individual trades could be quite profitable). But it’s simply the cost of investing in a bear market.

It’s the only way I know to protect your capital and guarantee you’re able to profit whenever the next bull market begins.

Bear Market Rule No. 3: Be open to opportunities outside of stocks

As I mentioned last week, cash is often the only true safe haven during the worst bouts of bear-market selling. However, you’ll often find that other assets can do well at certain times.

For example, since long-term interest rates peaked and began falling in the early 1980s, U.S. Treasury bonds have often performed well during bear markets in stocks.

Of course, that wasn’t the case in the bear market of the late 1960s and 70s. Back then, bonds generally fell alongside stocks as inflation surged. However, commodities — and gold and silver in particular — did well.

And during the 2001-2003 dot-com bust, value stocks — as tracked by the Russell 1000 Value Index — produced positive returns while most other stocks plunged.

Now, these are just a few examples.

This isn’t necessarily the case in every bear market. And I can’t tell you for sure which assets — if any — might do well in the next one.

But my point is that it’s not uncommon to find assets that “zig” while most others “zag” in a bear market. Most folks are simply too emotional to notice, or don’t have the capital to take advantage if they do.

You don’t necessarily need any fancy tools to find these opportunities. Just the awareness to look for them. But TradeSmith tools can be a huge help here.

Our market health tools can alert you when specific assets, markets, sectors, and commodities are bucking the trend. And you can easily set up watchlists for any additional assets you’d like to monitor.

That’s it for this week. Next time, we’ll wrap this series up with some specific investing and trading strategies you can use when the bear market begins.

As always, I’d love to hear what you think so far. You can reach me directly at [email protected]. I can’t respond to every email, but I personally read them all.