Thursday, June 10, 2010

Surviving A Bear Market

Given the recent weakness of the stock market - coupled with the reality of recessionary pressures - it's past time to start acknowledging we're entering a cyclical bear market.

However, it doesn't have to be a major distraction. Bear markets are more than survivable with a few simple steps. They require faith and passive attention, but a bear market doesn't have to be the disaster the media makes it out to be.

To preface, this article is not going to define a bear market. The Internet is loaded with definitions of what a technical bear market is, how and why they start, and what the end result is. The scope of this discussion is only to examine what you as an individual investor can do to minimize the downside of a bear market...or perhaps even thrive in it.

Though there are more than five basic bear market rules, these five may be the most critical.

1. Understand that a bear market is not an upside-down bull market.
Bull markets are characterized by prolonged, gentle rallies, with modest (and somewhat predictable) corrections, or pullbacks. Bear markets are characterized by sharp, quick drops, and even quicker, huge rebounds.....though the rebounds don't revisit previous highs. In other words, bear markets are much more volatile - in both directions - than bull markets. Using the same strategy or philosophy during both can lead to mixed results.

2. Understand that not all stocks go down in a bear market.
Yes, it's true...some stocks still go up in a bear market - you just have to find them.

3. Understand that most stocks do go down in a bear market.
Here's the headache to rule #2...the odds are technically against you if you're a 'long only' investor.

4. Understand that you will get no meaningful help from the media or government regarding when the bear market has begun, or when it has ended.
A bear market is usually defined as a decline of 20% or more in stock prices. Who has 20% to give up? Moreover, there is no official beginning or end to a bear market, and opinions vary greatly as to when we're actually at one end or the other. Ultimately, the individual investor must decide.

5. Understand that the economy and the stock market are not synchronized.
Stocks tend to be predicitive of the economy, rather than - and contrary to popular belief - reflective of the economy. The market almost always starts to rebound right in the middle of a technical recession, so don't be afraid to go against the grain if it feels right. (Side note: The National Bureau of Economic Research didn't say until November of 2001 that the U.S had started a recession in March of 2001. They didn't say until July of 2003 that November of 2001 was the end of the recession. In both cases, the stock market was well ahead of the NBER.)

These certainly aren't the only rules of a bear market, but a good place to start if you're not sure how to navigate one.

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