Identifying the type of market we’re in can be essential for setting an appropriate trading strategy. Most analysts believe we’re in a bear market, so investors need to pay attention to a different set of expected returns, average P/E ratios and market characteristics.
While there is no one definition of a bear market, it is usually seen as a general market condition where stocks are falling. It describes a market which is changing from one that is optimistic to pessimistic. Even companies growing earnings or with strong fundamentals usually see a downturn in share prices.
Markets tend to be governed by fear and greed. In a bull market, greed drives investors to push market prices higher and higher. The mistake that can be made by investors here is to buy too high near the peak.
In bear markets, price action is driven primarily by fear. This often means that prices fall even on good news and plummets on any bad news which is released. The mistake that investors can make here is to sell once the fall has already occurred.
So if there is a bear market, don’t be shy and consider selling early. Go defensive, or if you want to be aggressive, look at short positions (which means trading with a view that the value of the market or your stocks will fall).
A decline of more than 20% in the ASX 200 is usually considered a bear market. Technical analysts may follow this by using a longer-term trend tool such as the 200 day moving average.
Usually in a bear market, volumes drop off considerably leading to illiquidity and volatility.
Volatility describes how much prices move. Usually periods of high volatility have been associated with bear markets.
Even in bear markets, it’s not unusual to see upward movements of up to 20%. These traps are called bear market rallies and investors should be cautious not to get fooled that these are the beginning of a bull market.
Within equities, high beta stocks tend to be the ones that suffer the most in bear markets. Beta is how we measure risk in the market (read more about Beta).
In a rising market, high beta stocks are the ones leaping ahead; in a bear market they are the ones which sink the hardest.
High beta sectors are growth areas such as:
> Industrials
> Materials
> Energy and
> Consumer discretionary.
Defensive areas are often seen as the shelter from the storm. While these areas can also fall, they tend to hold onto value better than their growth counterparts.
Defensive sectors of the market are usually:
> Consumer staples
> Healthcare
> Utilities and
> Telcos.
Short positions look to profit from a falling market or price. E-minis provide a tool for traders to take short positions through ASX. You trade these positions like you would trade shares.
These products are riskier than shares, so make sure you do your homework. You can get more information from the ASX.
If you think that the market will fall, then you usually look at buying puts. Here is a list of five e-minis with exercise levels closest to where the market is.
Exercise
Issuer
XJOKMS
4447.6
MQB
XJOKMR
4535.6
XJOKOW
4508.9
CTW
XJOKRQ
4589.1
RBS
XJOKOR
4641.9
Before you trade warrants, first you'll need to sign a Warrant Agreement Form .
You can then read an overview about warrants and search for warrant codes. Just go to Quotes & news > Warrants
You'll also need to read Warrants — Understanding trading and investment warrants
With cash rates in Australia at 4.75%, cash can be a difficult proposition to beat in a falling market.
If you are looking for yield, hybrid securities are also an option. While hybrid securities can usually offer a higher yield than cash, they have more risk. That’s because they often have equity characteristics which may mean a capital loss.
Whether you go defensive, go cash or go aggressive, the key to trading a bear market is to recognise a falling market and have strong risk management and capital preservation controls in place.
Happy trading!
Julia Lee
Equities Analyst
Bell Direct
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