Tales of a Technician: How to Trade in a Bear Market
October 22, 2018
Last update: August 2021
The bears are roaming. And while their sudden emergence likely spelled losses for traders far and wide, the pain doesn’t have to persist. I look at this as a “fool me once, shame on you; fool me twice, shame on me” situation.
Heading into October, the uptrends in many market indexes were intact. So you’re forgiven if this month’s rug-pull caught you by surprise. But you are not forgiven if through your inaction further losses ensue. Perhaps the bears’ romp will be brief. Or maybe this month was just the appetizer, and a meatier (and bloodier) main course is around the corner. Either way now is as good a time as any to review a few of my favorite ideas for handling a bear market.
First, forget you yet mostly meaningless definitions. Use your head instead. Long ago someone came up with the definition of a bear market. A 20% decline, they called it. It was repeated and circulated. Round and round it went until it became dogma. When a stock peaks at $100 and then falls to $80, it’s officially entered a bear market.
Traders shouldn’t care about such arbitrary benchmarks. Instead, focus on the trend. If the daily trend is up, you’re bullish. If the daily trend is down, you’re bearish. And, well, right now the trend is down. So, you are bearish, muchacho.
Second, how you react when the market trend turns lower depends on your trading style.
The Passive Player
You own a long-term account full of stocks and such. What do you do when support gets shattered?
Well, first of all, you better be satisfied with your asset allocation. If you’re in 100% stocks, then you better be comfortable with experiencing the occasional 30+% drawdown. Because it will happen. Maybe the next one just began.
If you’re not then why, pray tell, is all your dough in stocks? Shift your allocation. More cash (it yields 2% these days, ya know), more bonds, more commodities, more stuff that’s uncorrelated. Got it?
Or
At a minimum how about you sell covered calls against your equity holdings to reduce basis, minimize volatility, and otherwise improve your odds?
Or
How about learning how to acquire put options to protect that portfolio? You can define your downside with the click of a button. Every one of these ideas is discussed in great detail in our Bear Market Survival Guide.
The Active Acrobat
If you’re an active trader playing short-term patterns such as those identified in our weekly reports, then I have a few suggestions:
- First, view rallies with skepticism as long as we sit below the 50-day and especially the 200-day moving averages. When the market gods turn the trend upside down the game of buying dips changes to one of selling rips.
- Second, cut your deltas. Swinging a big positive delta portfolio is fun when the market trend points higher is fine. Doing so when volatility is rampant, and the trend is pointing lower is rough. So don’t. Sell calls, buy puts, increase bear plays, decrease bull plays, etc…
- Third, the market is now guilty until proven innocent. Nobody knows how long this game of limbo will last. Every bear market starts as a 5% knee-scratch. But not every knee-scratch ends up infecting the entire market. Best to remain vigilant until the price action signals the coast is clear.
- Fourth, use volatility to your advantage, not detriment. Scaling-in is wise, but it’s especially so when the VIX flies north of 20.
- Fifth, gaps will become commonplace until said VIX retreats to the low teens. So plan accordingly and don’t act so surprised when you awake to the futures jumpin’ around like a jackrabbit.
Alright. That’s enough for now. Stay frosty, friends.
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Thanks Tyler