How To Trade in a Bearish Market

By Tradier Inc.

May 12, 2022

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2 min read

Image: S&P 500, year-to-date. Source: BigCharts

The leading stock market indices have declined in 2022. After the rally that took the stock market to record highs following the bottoms created by the global pandemic in early 2020, the markets ran out of upside steam. Rising inflation, the first major war in Europe since World War II, supply chain bottlenecks, a rising US dollar and other factors created the uncertainty weighing on the stock market. The technology sector that led the way higher in 2020 and 2021 is leading the way to the downside in 2022. The market’s overall tone has shifted from buying opportunities on dips to selling opportunities on rallies. The bull has transformed into a bear.

Bear markets have unique characteristics that create opportunities for traders and investors with their fingers on the pulse of markets. Success in bear markets depends on following rules that can eliminate or reduce the stress and uncertainty when confronting the bear.

Rule one: The weak tend to get weaker

Weak stocks tend to do the worst during bear markets.
Weakness comes from poor earnings or an adverse reaction to good earnings.
Strong stocks tend to outperform the market during bearish trends.

Rule two: The trend is your friend

The path of least resistance of prices reflects the market’s sentiment.
Sentiment is the wisdom of the crowd.
Crowds make wiser decisions than individuals.

Rule three: Hedging avoids panic

Panic is an emotion that often leads to losses and missed opportunities.
Hedging portfolios during volatile times enables you to sleep at night and avoid the impulse to panic.
Hedging can protect the downside while allowing for upside participation.

Rule four: Don’t pick bottoms or tops

It is virtually impossible to pick tops or bottoms in any market.
Markets often rise or fall to irrational and unreasonable levels that defy logic.
Identifying a top or bottom is all about luck and has little to do with skill.