The thought of a possible bear market strikes fear in the hearts of many stock market investors. However, stock-market history enthusiast that you are, you know that bear markets are just a part of the ongoing stock market cycles. When the next bear market strikes, you will be prepared with some strategies to profit from the downturn.
Although stock short-sellers sometimes have a bad rep, selling shares short is a legal and acceptable way to profit from falling share prices. Short selling is selling shares you don't own and buying them back at a lower price, profiting from the decline in price. You sell a stock short first by borrowing the shares from your broker and entering a sell order for the shares. Your brokerage account will show a short position until you use a buy order to get the shares back. Your profit is the difference between the price at which you sold and the lower price at which you bought it back. To sell a stock short, you need a margin account with your broker. The borrowing and returning of shares happens automatically when you place short sale orders online.
Exchange-traded stock options come in two flavors -- puts and calls. A put option gives you the right to sell shares at a preset price. In action, a put contract will go up in value if the stock underlying the put goes down in price. Option contracts are valid for a limited time, so you need to sell any puts you purchase before the expiration date. To trade options, you must apply to have option privileges added to your brokerage account. You can add option trading to cash, margin or even individual retirement accounts (IRAs).
The financial companies that develop and sponsor exchange traded funds -- ETFs -- have produced funds categorized as inverse ETFs. While a regular ETF directly tracks the changes of a specific index, these funds are designed to change value in the opposite direction of the target stock index or commodity. For example, an inverse S&P 500 ETF will go up if the widely followed stock index goes down. Leveraged, inverse ETFs move up or down at two or three times the change in the underlying index. You can buy inverse ETF shares through any stock brokerage account.
Bear Market Considerations
Although every bull market and bear market has its own results, one major difference is that bear markets are usually short with steep price declines while a bull market can last for years with steadily increasing prices. If you are wrong with the timing of your bear market strategies, you could be losing money while the market goes up instead of down. Keep a close eye on your bear market trades, limit your losses, lock in profits -- and don't get greedy.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.