A bear market is a market where stock prices are continually falling. A bear market represents the bearish attitude of investors who are pessimistic about the future of the economy. When investor sentiment is bearish trading the stock market is not as easy as trading it when there is a bull market. There are really only two ways to trade a stock bear market and one of them is not to take any notice of share market tips and continue purchasing stock as if you were in a bull market. The two ways to trade in a bear market is to either short sell stock or use an option strategy to protect your existing portfolio of stock.
What is short selling? When you buy a stock you essentially are buying or owning a piece of the company you have the stocks in. You do this through a stock broker or on rare occasions directly through the company. Buying and selling shares through a broker requires that you open an account with the broker which can either be a cash account (you pay cash for your purchases of stock) or a margin account (you borrow some of the funds required to buy the stock from the broker and the stock you bought is collateral for the broker).
When you short sell you are actually selling a stock that you don’t own, but that you promise to deliver at a later date in the future. What happens is that when you short sell your stock your broker will actually loan the stock to you, either by taking it from their holding inventory, or from another customer of the firm or from another broker house. The stock is sold for you and the funds from the sale are credited to your cash or margin account with the broker. The idea of course is that you believe that the price of the stock will fall, maybe from a market tip, or you have done your research and come to the conclusion that the stock will lose value and at a later stage you can buy back the stock at a lower price than what you sold it for and make a profit. To close out the short sell you have to buy back exactly the same amount of stock you originally sold. Of course if the stock price has risen you will lose money.
You can actually hold a short position for as long as you want, however, the broker will charge you interest for the duration of time you short. Also because you don’t possess the stock that is on loan to you and then you sold, you are obliged to pay the owner of the stock any dividends or rights issues which have occurred while borrowing the stock. Furthermore, if there is a stock split during the period you are borrowing the stock, you will owe more shares at a lower price.
The second way to trade in a bear market is to protect your portfolio by buying put options on the stock you hold. You will need to make sure the puts expiry dates are beyond the date of when the stock price falls. This strategy has a downside which is limited to the premium paid and can be very rewarding when the stock price falls.
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