How to Make an Adjustment for a Declining Market

by Michael Wolfe

A "bear" market, or a market in decline, is often synonymous with financial losses. However, markets in decline can actually represent significant financial opportunities for savvy investors, so long as they make appropriate corrections. This is because not only can an investor capitalize by shorting certain assets, but he can also move his money into sectors apt to experience an upswing in a declining market. Additionally, he may be able to pick up some valuable bargains at lower prices on the dips in a declining market.

1. Identify your risk areas. The first thing to do when the market begins to decline is to identity where you expect to take a financial hit in your portfolio. For example, market high-cap stocks will often take a severe hit as investment capital dries. Similarly, oil futures might lose value as the demand for petroleum slows along with the economy.

2. Move into safer assets. While some assets will take a hit in the declining market, others will remain relatively untouched. For example, bonds issued by the U.S. Treasury tend to consistently hold their value during declining markets. In addition, certain types of commodities, such as gold, have always been safe havens for trouble investors. At worse, you can stay liquid and convert your money into a relatively safe currency, such as the dollar.

3. Go short. One of the main ways of making money during a market decline, particularly if you're able to get out in front of other investors, is to short stocks. This involves buying put options on stocks -- the option to sell the stock at a certain price -- from other investors. If the price of the stock goes down, the value of the put option will increase.

4. Identify who benefits from the decline. In every declining market, a few sectors remain relatively unscathed by the financial havoc or, in some cases, even benefit from it. This is because the sector may stand to profit from the event causing the decline. For example, if the market decline is caused from fears over a war, some investors will invest in defense stocks.

5. Hunt for bargains. When the market declines, most stocks will suffer a drop in value, regardless of their underlying value. While for some stocks this may represent a logical correction in price, investors will sometimes throw the baby out with the bathwater and cause a number of blue-chip stocks to suffer losses as well. Savvy investors hunt for undervalued stocks and snap them up.


  • "Bear-proof Investing"; Kenneth E. Little; 2001

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