This is a painful subject. And most people just put their head in the sand.
A bear stock market is going to affect your portfolio, obviously. But it is also going to reduce your wealth in more hidden ways. For example, your retirement account such as IRAs and 401ks are going to take a hit also. That affects your wealth and retirement.
But a bear market will also affect your job and housing. Are you in a company that will lay you off if the economy turns down. Is your company going to lose customers due to the bear market or recession. What is going to happen to your mortgage due to the bear market?
Obviously, I can't answer these questions for you but you need to think about them.
So how can you protect yourself from a bear market.
Most likely, you have a portfolio of stocks. The first thing to do is to put protective stops on all the stocks to make sure you don't lose a lot of money. A little is OK but we never want big losses.
In fact, you should only be holding stocks that are in bull markets. Period. I know it can be hard to get out of positions, but remember you can buy them back later at a lower price! But you need to protect yourself right now and think about buying the stock back later.
Next, we need to put on some hedges. You now probably got rid of some of your stocks and you have protective stops on all your remaining positions. Great.
But we also need to hedge the total portfolio. We need to put on bearish strategies to offset our bullish portfolio.
We can do this by adding some of the following:
- Buy inverse ETFs
- Buy puts on the SPY
- Short sell the SPY
These are the three core strategies to hedge your porfolio.
For example, let's say we have a $100,000 portfolio. We would want to, say, buy $100,000 of an inverse ETF to hedge our portfolio. Now we don't really care what happens to the stock market.
If the market goes up, we will make money on our stock portfolio but lose on our hedge. And vice versa. The point of a hedge is to insulate you from market movements.
The amount of the hedge is determined by the hedge ratio. This hedge ratio takes into account such things as the volatility of your portfolio compared the market volatility, how much margin you have in your account, and how long you will hold the position. Unfortunately, the exact calculation of the hedge ratio is beyond the scope of this article.
The timing of when to put on and take off the hedge is obviously very important. The main thing to consider is that you need to use shorter term techniques because bear markets drop quickly and rally quickly. In addition, they often bottom in a V shape not a nice slow W.
Be sure to not stick your head in the sand. Don't become a victim of a bear market. Take control of your portfolio and learn to protect yourself from the bear.
Good bear trading,
Courtney Smith
P.S. I am putting our famous How To Profit From Bear Markets course on sale for 50% discount.
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