How To Prepare For The First Bear Market Of Your Trading Career
For the first time in more than a decade, investors experienced a bear market in March 2020. If you blinked, you might have missed it. Within about a month, the SPDR S&P 500 ETF Trust (NYSE: SPY) transitioned back into a bull market, making the 2020 sell-off the shortest bear market in U.S. history. Historically, S&P 500 bear markets have lasted about 13 months on average and have come around about once every 6.2 years. Investors who bought into the market since 2009 have only experienced the 2020 mini bear market. Investors who bought in for the first time last year have only ever experienced a bull market. Here are eight tips for investors looking to make sure they are prepared to navigate their first full-length bear market, whenever it arrives. 1. Have Plenty Of Cash For The Near-Term It may be tempting to pour all of your savings into stocks to buy the next bear market dip, but there’s a very good chance the next bear market will last longer than 30 days. The previous bear market back in 2008 and 2009, for example, lasted nearly a year-and-a-half. In the meantime, you must set aside enough cash to cover bills, food, rent and emergency expenses. 2. Don’t Trade On Emotions Seeing your account in the red day after day for a year-and-a-half can take a tremendous mental and emotional toll. You will likely feel the entire spectrum of negative emotions, from anger to sadness to embarrassment to shame. There’s nothing wrong with feeling these emotions. What you want to avoid is making trades based on these emotions. Investing should be a cold, calculated process based on logic and reason, not an emotional Band-Aid to make you feel better after a bad day in the market. 3. Think Long-Term Whether they lasted 33 days or 31 months, there is one thing all past bear markets have in common: they all came to an end eventually. The S&P 500 eventually made new all-time highs following each bear market as well. Timing the exact bottom can be nearly impossible, even for the most experienced traders. But investors who bought the S&P 500 at any point in each bear market eventually ended up turning a profit. Patience is much more important than timing. Related Link: 4 Secular Growth Stock Ideas: Chewy, Amazon, Alphabet, Equinix 4. Keep Some Perspective In the middle of a bear market, it will seem like the sky is falling. It will seem like whatever is happening — whether it be COVID-19, the mortgage market collapse or the bursting of the dot-com bubble — is the biggest threat the economy has ever faced. In reality, the U.S. economy has shrugged off wars, recessions, depressions, hyperinflation, stagflation, countless booms and busts and now a pandemic. Bear markets aren’t a sign of the economic apocalypse. They are a healthy part of the natural market cycle. 5. Diversification Is Your Friend In most bear markets, the vast majority of stocks, sectors and investment themes all take a big hit. Some companies will inevitably be forced into bankruptcy, and their stocks will go to zero. Some sectors or businesses may be permanently hindered and will severely lag the overall market during the recovery. To protect your portfolio on the way down and the way back up, stay diversified by buying index funds or other diversified investments. 6. Set An Appropriate Risk Level Now Once the bear market has begun, it’s too late to avoid the negative impact. If you’re close to retirement age or planning to buy a house, throw a wedding or have any other major financial expense coming, the time to dial back your risk is now, before the market crashes. Raise your cash balance by putting that money into a high-yield savings account or a certificate of deposit at an FDIC-insured bank. Your returns will be minimal given the low interest rate environment, but your cash position will help mitigate your near-term market risk. 7. Have A Watchlist Buying the dip is a strategy that has worked during every single bear market in history. But you don’t need to be scrambling to determine what to buy and at which price in real time. Before the bear market begins, make a list of stocks that you’d like to own if the price were right. That watchlist gives you a starting point of places to look when a market sell-off picks up steam. Taking a targeted approach to buying the dip can help save time and minimize bad investments. 8. Reduce Your Margin If you have $50,000 cash in your account and you borrow another $50,000 on margin to invest as well, a typical 30% bear market pullback would theoretically cost you 60% of your original $50,000. In addition, margin calls could force you to sell stocks or funds at the worst possible time when prices are at their lowest. The responsible use of margin is a perfectly valid investment strategy, but overleveraged accounts can be particularly vulnerable during bear markets. 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