Bear markets are without doubt the toughest markets to trade. They can punish traders. It’s the type of markets where fortunes are lost, 401Ks get crushed and many traders give up. However, they also lead to amazing opportunities for strategic traders who know what to look for.
Here are seven important tips to profitably trade bear markets.
1. Less is more (trading frequency)
What works in trading goes against our own human nature. This is most evident during volatile markets. When the world around us is crazy, we tend to get more crazy. Maybe there’s a good biological reason for this, but in the trading game, when the market gets volatile, we need to be less volatile. We do this by trading less.
You could say less is more. That’s because in volatile markets, there are fewer real trading signals. Most of it is just noise. If you are overtrading when there is just noise, you have no directional edge. In essence, you are basically just gambling.
Trade when you have a strong signal based on your research and tested setups.
2. Let market breadth guide your directional bias
While price action is most important when gauging the market during a selloff, we can get subtle clues that predict continuations or reversals from analyzing market breadth. Our market breadth indicators track the underlying strength of the market.
For example, a market index like SPY might be down 5%. If over half of the stocks that make up SPY are green, that indicates a positive divergence. In this spot we are on the lookout for a potential reversal.
However, if more than half the stocks are down more than 5%, we expect a continuation of the downtrend.
3. Is opening strength bought or faded
A common theme in bear markets is that strong opens are faded. This usually happens in the midst of a downtrend. Some of the biggest purges happen off morning strength. Once positive opens start to hold, that’s when you start thinking of putting bullish money in play.
4. Are moving average remounts faded or do they hold up
In bullish markets, one of my favorite setups is the moving average remount.
This is a variation of the “buy the dip” play. The dip starts to look more like a failure as support levels break, but the stock will make a quick comeback and “remount” that support level. This is where we enter off a remount “continuation pattern.
While this is a money setup in bull markets, in bearish markets the remount lacks the strength to continue and ends up failing. This often leads to the next big leg down.
5. Do support levels hold or break
This one’s pretty simple. If support levels continue to break, the bear market is in a continuation trend. Don’t fight it. Only go long once these levels start to hold.
6. Powerful bounces
Surprisingly, the most powerful market bounces don’t come in bull markets. Downtrending markets that have purged months of gains often lead to powerful bounces that will ultimately fail. However, we can play these bounces using rubber band setups. These are “quickie” longs in oversold stocks that lead to explosive gains, as long as you get out before the failure.
7. Trade the leveraged ETF
During bear markets almost everything is moving in unison with the market. There’s no need to pour over lists of stocks when very few are going to beat what you can gain using leveraged ETFs. My go to leveraged ETFs are SPXL, SPXU, TQQQ, SQQQ, SOXL, SOXS, TNA and TZA. These ETFs track SPY, Nasdaq and the Russell 2000.
Let’s apply these tips
In the following video, I show you how to apply these tips to the current “coronavirus” bear market of 2020.