Bear markets can present amazing opportunities for long-term investors. Those who buy stocks while the market is down tend to be rewarded in the long run.
That said, investing during a bear market is not as straightforward as investing during a bull market. If you’re thinking of buying stocks in the current bear market, there’s one thing you should know.
Beware of bear traps
It’s no secret that in a bear market, the general trend of the stock market is down. What many investors don’t realise, however, is that stocks don’t fall in a straight line. Every now and then, the stock market will bounce a little (as selling activity temporarily weakens), before resuming its downward trend. This ‘false reversal’ pattern is called a ‘bear trap’, and it can be dangerous for investors.
The reason bear traps are dangerous is that they lure investors back into the market at higher prices, right before the next down-leg of the bear market. Stocks rise a little, and investors think the worst is over. As fear is replaced by greed, they scramble to get back into the market. Then, the market suddenly takes another dive and those who bought at higher prices get crushed.
This is summed up well by AJ Bell’s investment director Russ Mould, who said recently: “Analysis of the four previous downturns in 1987, 1998, 2000 – 2003 and 2007 – 2009 show that those bear markets were actually littered with sharp rallies which cruelly turned out to be nothing more than bear traps for the unwary, who were tempted into a ‘buy-on-the-dip’ strategy, only to quickly find themselves in trouble.”
FTSE 100 bear trap?
Looking at the FTSE 100‘s movements in the last few days, my hunch is that we may be seeing a bear trap right now. The coronavirus situation is far from over, yet the FTSE has rebounded roughly 15%. That kind of bounce seems a little premature to me. I would not be surprised to see another down-leg from here before the market generates a sustained recovery.
As Mould says: “There remains the risk that any such advance proves fairly temporary should news on the viral outbreak continue to get worse and policy measures require a longer lockdown – and potentially deeper hit to global economic activity – than currently hoped.”
Mould also points out that six of the FTSE 100’s 10 single largest percentage daily gains in recent times came between September and December 2008 (during the Financial Crisis). Yet the index didn’t bottom until March 2009 – something to keep in mind after this week’s huge jump.
Investing in a bear market
So, what’s the best way to invest in bear markets?
Well, one piece of advice is to keep your emotions in check. Don’t let fear and greed drive your investment decisions. If the market suddenly rallies hard, don’t feel that you need to load up on stocks at higher prices to avoid missing out on gains.
It’s also a good idea to refrain from investing large lump sums at once. Drip-feeding money into the market slowly at regular intervals will enable you to capitalise if stocks fall further.
Finally, I think it’s smarter to buy stocks on the big down days instead of the big up days. You can still lose money this way, of course, but by buying shares at lower prices, your portfolio will recover faster.
Views expressed in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.