Bear markets are an unwelcome but inevitable fact of life for investors. Stock prices are falling and everyone is trying to sell the shares they own. Except that’s not exactly true. For every share of stock sold, there is an investor somewhere who purchased that share. The investors who are buying expect to benefit from the stock market plunge. There is no magic or insider knowledge involved. You can learn how to benefit from market downturns by understanding how bear markets work and calmly applying a few basic investing strategies. At the very least, you can weather a stock market plunge with minimal losses.
1. Maintain a diversified investment portfolio to minimize risk even when the market is at its most bullish. This will keep you prepared to cope with a stock market plunge. For example, if you keep a portion of your investment dollars in investment-grade bonds, you will continue to receive the interest income the bonds provide. In addition, when the stock market turns bearish, interest rates are likely to decline. A fall in interest rates usually leads to higher bond prices, which can help offset stock losses.
2. Heed the warning signs that a bull market is reaching its peak. Typically, you can expect stocks to be rising rapidly as overexcited investors enter the market and bid up prices. Interest rates may be rising and market volume higher than normal. Investors often convince themselves that the bull market will last indefinitely and disregard traditional approaches to valuing shares. By recognizing the signs, you can adjust your investment strategy. Shift your portfolio to low-risk securities and increase cash reserves so that you are prepared to take advantage of the buying opportunities an impending bear market will offer.
3. Use dollar averaging to buy stocks during a stock market plunge. Many high-quality stocks will be available at bargain prices. The idea of dollar averaging is to invest approximately the same amount of money on a regular basis, such as once a month. The effect is that you buy fewer shares when the price of a stock is high and buy the most shares when the price is low. By following this strategy, you do not need to try to guess when the market reaches its low point. Dollar averaging ensures you purchase the most shares at bargain prices.
4. Invest in companies that are recession resistant. Certain industries tend to fare better than others in a poor economic climate. Some examples are consumer goods such as food, clothing and household products people must continue buying. Health-care companies also tend to do well during market plunges. Large, well-established firms in these industries may take a hit in a stock market plunge but are then available at lower prices than you’d normally be able to get.
- Exercise caution in making use of sophisticated strategies such as selling short, buying on margin or trading stock options for profit. These are potentially profitable, but they are also high risk. You are wise if you avoid them unless you have considerable expertise and experience as an investor.