Once investors feel that this scenario is about to happen or is already happening, they can utilize a variety of techniques; the optimal method depends on the investor’s tolerance for risk, investing time horizon, and overall goals.
A defensive approach is frequently used by investors who want to keep their stock market stakes. This technique entails investing in huge corporations with robust account balances and a long history of operations: solid, large-cap companies are hardly hurt by a general slowdown in the economy or financial markets, making their stock prices less vulnerable to a significant drop.
Protective Put Options: Purchasing protective put options is a popular way to play defense. Puts are options contracts that provide the owner the possibility but not the duty to trade a stock at a specified price once or before the contract’s expiration date. Hence, if one owns 100 shares of the SPY S&P 500 ETF and paid $250 for them, one can acquire the $210 strike puts that expire in six months and pay the option premium (option price).
In this scenario, if the SPY falls to $200, one still has the option to sell stocks at $210, thereby locking in a $210 floor and preventing additional losses. Even if SPY drops to just $225, the market value of those put options may rise because the spot rate is now nearer to the market rate.
Purchasing Bargains: A bear market may provide an opportunity to purchase additional equities at lower prices. An approach known as dollar-cost averaging may be the best way to invest. Regardless of how bad the news is, you invest a tiny, predetermined sum, say $1,000, in the stock market every month. Invest in stocks that are both valuable and pay dividends; because dividends make up a large portion of equities’ gains, holding them makes bad markets shorter and less difficult to endure.
Expanding one’s portfolio to include investment options with opposing performance to the stock and bond markets is also beneficial. When equities fall, for example, bonds typically increase as investors seek safer investments; however, this is not the situation every time.
Selling all of your stocks and holding cash or investing the proceeds in considerably more solid financial assets, like short-term government bonds, is one of the smartest and most radical techniques. A trader can lower their stock market risk and mitigate the impact of the raging bear by doing so. However, many, but not all, traders lack the skill to accurately gauge the market. Trading it all and missing the rebound, commonly known as capitulation, might lead an investor to miss out on the gain.
Short positions can be acquired in numerous methods to profit from a declining market, such as short selling, purchasing shares of an inverse ETF, or purchasing speculative put options, most of which will gain in value as the market decreases. It is indeed worth noting that every one of those quick solutions has its mix of hazards and restrictions.
Organizations that provide the essential needs of businesses and consumers, such as basic foodstuffs (people would eat while the economy is in a slump), utilities, or suppliers of other basic commodities like toiletries, are among the so-called defensive stocks. These organizations tend to survive declines because they have solid financial situations, such as a large cash position to fund ongoing operational needs.
But from the other side, riskier businesses, such as small growth businesses, are often avoided because they are more likely to have the financial stability needed to weather declines.