A bear market for stocks is coming.  Every day I see at least one article with a headline that echoes this forecast.  And it’s absolutely true --  after a six-year bull market, a bear market is definitely coming.  The problem is, we don’t know WHEN it’s coming, how long it will last, or how severely it will impact stock prices.  So it’s always safe to say that a bear market is coming…eventually. 

But there is no reason to be alarmed.  Not only can you survive the next bear market, you can even prosper from it.  Today I’m going to give you some techniques you can use to either reduce your portfolio losses, or even to make some money off the big bad bear. (For related reading, see article: Adapt To A Bear Market.)

By definition, according to Investopedia, a bear market is a "market condition in which the prices of securities are falling, and widespread pessimism causes the negative sentiment to be self-sustaining. As investors anticipate losses in a bear market and selling continues, pessimism only grows. Although figures can vary, for many, a downturn of 20% or more in multiple broad market indexes, such as the Dow Jones Industrial Average (DJIA) or Standard & Poor's 500 Index (S&P 500), over at least a two-month period, is considered an entry into a bear market." 

The dilemma is that when stocks begin to fall, we never know whether it will be a simple 5% or 10% correction, or a deeper decline into bear market territory.  If you wait too long and stocks rise again, you’ve missed an opportunity to buy on a dip and won’t profit from the bounce back in prices.  But if you are too quick to pull the trigger, you may see your new stock purchases continue to decline further.

The 10% correction is not the problem.  Most investors can stomach that.  It's the 78% correction, as we saw in the Nasdaq tech bubble bursting from 2000 to 2002, or the 54% lost by the Dow between 2007 and 2009.  And every time there's a 10% correction, the financial cable shows haul out the usual Wall Street cheerleaders to calm the public with, "Hold on, don't panic, buy more".  

Many times they’ll suggest buying dividend stocks as a hedge.  But if you go all in when the market falls 10% and then it falls another 40% or 50%, that 5% dividend is a very small consolation in light of your portfolio destruction.

So then what can we do to really cushion our losses, and even make some money in a bear market?  Here are four strategies for overcoming the next bear market:


Strategy 1:  The 401 (k)

One lesson from the bear market of 2007-2009 is that if you buy index funds at regular intervals through a 401(k), you will prosper when the market finally does rebound. Those who used this strategy didn’t know whether the bear would end in December 2007, June 2008, or as it finally did, in March 2009.  

People told me their 401(k) was cut in half by the time the bear market ended, but all of the shares that were bought on the way down became profitable when the market finally turned around and climbed higher.  By 2015, those who hung in there have made enormous profits from the cheaper shares purchased during the downturn, plus company matching, plus all of their money that they got back (and then more profit) from the shares bought before the peak in 2006-07. So it’s best not to go all in at any one time, but just to keep investing smaller amounts at regular intervals.


Strategy 2:  Buying short and long term puts

If you feel that a bear market is developing and have substantial long positions in the market, another useful strategy is to buy inexpensive short and long-term puts on the major indices.  A put is an option that represents 100 shares of stock, and has a fixed time length before it expires worthless.  If you buy puts on the Dow Jones Industrial Average, S&P 500, and Nasdaq and the market declines, your puts will gain in value.  Because options increase or decrease by a much larger percentage than stocks, even a small number of put contracts can offset your long stock position losses.  Just remember to sell your puts at least a few days before their term date, as upon expiration they become worthless. (See video: Put Option Basics.)


Strategy 3:  Selling “naked” puts

Selling a “naked” put involves selling the puts that others want to buy, in exchange for cash premiums.  In a bear market, there should be no shortage of interested buyers.  When you sell a put contract, your hope is that the put expires worthless at or above its strike price.  If it does, you profit by keeping the entire premium, and the transaction ends.  But if the stock price falls below the strike price, upon expiration you are usually forced by the brokerage to buy 100 shares of the stock per contract at your strike price, no matter what the current price may be.

The premium does give you some downside protection.  For example, let’s say you sell a July 21st put with a $10 strike, and the premium paid to you is .50.  Since your account gets credited with the entire premium upon expiration, if the stock is at $9.50 and you are forced to buy 100 shares of the stock at $10.00, you are still at break-even.

The best strategy is to keep selling short-term puts on solid companies that you wouldn’t mind owning if you have to, especially if they pay dividends.  Even in a bear market, there will be periods where stock prices rise, giving you profits from the put premiums.  On occasion you may be forced to buy a stock, at which point you can choose to sell at break-even, a slight profit, or a slight loss.  Although it’s possible, it is very unusual to lose a large sum of money when selling puts, unless your time frame is extremely long.  It’s also estimated that about 75% of all options expire worthless, which is really what you want when you are selling puts. (For related reading, see article: Prices Plunging? Buy A Put!)


Strategy 4:  Finding the assets that increase in price

I find it helpful to research past bear markets, in order to see which stocks, sectors, or assets actually went up or at least held their own when all around them the market was tanking.  Sometimes the precious metals, like gold and silver, outperform.  Food and personal care stocks, often called “defensive stocks”, usually do well.  There are times when bonds go up as stocks decline.  Sometimes a particular sector of the market, such as utilities, real estate, or health care, might do well, even if other sectors are losing value.

Many financial websites publish sector performances for different time frames, and you can easily see which sectors are currently outperforming the others.  Begin to allocate some of your cash in those sectors, as once a sector does well, it usually performs well for a long period of time.


The Bottom Line

So as you can see, we do not have to fear the big bad bear market, but rather by employing some alternative strategies, we can do quite well during those times when many others are suffering major losses to their portfolios. (For related reading, see article: Digging Deeper Into Bull And Bear Markets.)



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