Investors cringe at the thought of a bear market and shudder with fear thinking about losing their money in such an environment. Their fear of downturns keeps them from participating in strategies that do well when the market is going down.
A bear market is defined as a point during which stocks are falling in value; in its most common form, it is when the stock trades below the 200-day moving average. Bear market trading strategies are also very effective and even lucrative, despite their notoriety.
In this video, we’ll share a trading strategy in a bear market that speaks to the prospects of profit that a trader can see from trading in such downtrends. By the end of this video, you’ll know how to turn the market on your side.
Bull vs Bear Markets: What’s the Difference?
Before we dive into our trading strategy, let’s set some basics down first with bull and bear markets. What exactly are we referring to here? It is fairly easy:
Bull Market: A trend wherein stocks generally move upwards, and trading is more frequently higher than the 200-day moving average.
- Bear Market: Downside price of shares, usually when the trading price is below the 200-day moving average.
Bear Market Trading Strategy
In that case, our bear market trading strategy will be mean reversion-based. We’ll focus particularly on the NASDAQ 100 index, which is mirrored in the QQQ ETF. Here’s how we structure the strategy:
- Long: When 2-day Relative Strength Index comes below 10 we go long. It indicates that the stock is oversold and needs a bounce.
- Exit: Sell when price closes above yesterday high, markets showing strength.
- Market Filter: This strategy is filtered strictly to times when QQQ is trading below its 200-day moving average, ensuring we are in a bear market environment at this point.
Backtesting the Strategy
We ran backtests using our bear market strategy with the NASDAQ 100 index. Below is what we found:
Bull vs. Bear Markets Performance
- Performance: Bull Market Performance Performance gave respectable returns when trades are filtered to only occur when QQQ is above the 200-day moving average, but not as great as in bear markets.
- Bear Market Performance: Some pretty good results were seen – the strategy performed very well in all the bear markets since 2000, producing an average gain of 1.3% per trade in the bear market compared to average gains in the trades of the bull market.
Historical Backtest Review
Reviewing individual market downturns confirms just how resilient our bear market strategy is:
- Dot-Com Crash: It even managed to produce positive gains during that time of the market fall by such large amounts.
- Financial Crisis: Even here, the strategy worked as well, generating profits at the time when the market was in shambles.
- 2022 Bear Market: Recent bear market conditions also had positive returns through our trading strategy.
The equity curve is continuously showing better performance in the bear market compared to bull market conditions.
Why Bear Markets Can Be Helpful
You must find it rather counterintuitive to embrace bear markets. But several reasons support the notion that bear markets can be helpful:
- Market Inefficiency: Generally, uncertainty leads to mispricing of such assets. The astute trader can exploit those imbalances and so prosper.
- Volatility: If the overall market is in a bear market, volatility tends to be significantly higher than it might be under other market conditions. Here, if one wants to benefit from price movements, this would likely represent an ideal situation to gain profits.
- Opportunities for Long Sides: There is no reason you have to short to make money in bear markets; in fact, we have several long strategies that actually work well during market conditions like these, and we present some of them to you below.
Shorting in Bear Markets
Because our main strategy enters a long in bear markets, it’s also important to appreciate the benefit of short selling in such periods. Here is how a shorting strategy can be applied appropriately during the time of ups and downs.
- Trend Filter: We use the 200-day moving average as a trend filter. If QQQ is trading below this average, we enter into short positions.
- Performance Insights: The data reveals that a bear market is the time when one should short. General market volatility is twice as high compared to the volatility in a bull market.
- Volatility and Trading Efficiency: Negative correlation between volatility and trading efficiency means that when the market is unstable, trading efficiency will again benefit from even higher prospects for a profit from trading.
Conclusion: Love the Bear Market
Summarily, bear markets are intimidating; however, they also hold certain prospects for traders willing to play about with their strategies. Our strategy in the bear market shows a possibility of positive returns from a downward market and shows that market conditions can be used to one’s advantage.
Trading with a bear market mentality will enable a trader to reap the potential of an uncertain environment-that is to say, in either mean reversion or calculated short-selling. With your knowledge and incorporating the strategies above, you will emerge from this bear market not just alive but hopefully thriving. And as is often the case, flexibility and going for opportunities characterize successful trading, especially when the market looks dreadful.