How To Make Money In A Bear Market (2 Simple Steps)

Last Updated on November 28, 2022

It feels great to make money in a bear market. It’s not about schadenfreude, but more about mastering the markets. So, how do you go about making money in a bear market? In this article, we indicate how to make money in a bear market with two simple steps.

You make money in a bear market by sticking to your plan and by trading both market directions, both long and short. Make sure you are prepared and continue trading your plan and keep pushing buttons.

Let’s go on to discuss more how to make money in a bear market. Overall, traders should be happy when a bear market comes around. You can possibly make more money on the long side (see our backtest below), and short trades normally start working.

Continue reading and you’ll understand why.

A bear market tempts you to commit cognitive mistakes (trading biases)

The stock market (and all other markets) are cyclical. They go up and down, but the stock market spends much more time going up than down. Because of the cyclical nature, the investors’ interest in markets is highly correlated to whether it’s a bull or bear market.

If the market is bullish, more people are making money (at least on paper and in theory), while in a bear market many lose interest completely.

Even worse, because people buy when prices go up and sell when they turn around and head south, many are even losing money in a bull market. Humans do cognitive mistakes all the time and sometimes we are our own worst enemy (trading bias in trading).

(We highly recommend the following short but interesting read about cognitive mistakes: The Art Of Thinking Clearly. The book is written by Rolf Dobelli and is an easy read. It covers the 99 most common mistakes humans do (over and over again)).

The mistake of buying high and selling low is best illustrated with a practical example. The quote below is taken from a book called Quantitative Value by Wesley Gray and Tobias Carlisle:

In the decade to December 31, 2009, the Wall Street Journal reported that the best-performed U.S. diversified stock mutual fund according to fund-tracker Morningstar was Ken Heebner’s CGM Focus Fund. Over the decade, the fund had gained 18.2 percent annually, beating its closest rival by 3.4 percent per year, which is exceptional. The typical investor in Heebner’s fund, however, lost 11 percent annually. Investor returns, also known as “dollar-weighted returns,” take into account the capital flowing into and out of the fund as investors buy and sell. The investor returns were lower than the fund’s total returns because investors bought into the fund after it had a strong run and then sold as it hit bottom. Heebner’s fund surged 80 percent in 2007, and then investors poured in $2.6 billion. The following year, the fund sunk 48 percent, and investors yanked out more than $750 million. Said Heebner: “A huge amount of money came in right when the performance of the fund was at a peak. I don’t know what to say about that. We don’t have any control over what investors do.” This behavior caused the investor returns in Heebner’s fund to be among the worst of any fund tracked by Morningstar. Amazingly, this means that the worst investor returns were found in the decade’s best-performed fund. We are each our own worst enemy.

The majority of the investors in the best-performing fund managed to lose money! You don’t want to be among those “losers”, and even better, you want to make money in a bear market.

To make money in a bear market it’s important that you are aware of the biases against bear markets. A bear market is scary because several things happen:

  • Volatility picks up. Daily swings of many % are common.
  • News is always negative. News amplifies negative emotions. (In general, here is why we recommend traders avoid reading news.)
  • We tend to look for and read the news, when we shouldn’t.
  • We override our trading signals.

Let’s go on to define a bear market:

What is a bear market?

First, we need to define a bear market. We like to make things simple, and we use the 200-day moving average to separate a bear from a bull market. When the close is above the average, we have a bull market, and when the close is below, we have a bear market.

Pretty simple, but backtests show that it works pretty well:

How long do bear markets last?

In previous research we have done, we found out that the stock market spends most of its time as a “bull market”. Since 1960, the S&P 500 has spent 30% of its time in a bear market (thus 70% is a bull market).

This makes sense. Why? Because the stock market has a “built-in” upward bias due to inflation and productivity gains. For this reason, we believe the stock market is the best place for traders, not forex or commodity markets (read here for our take on why avoid forex).

However, bull and bear markets also depend on which market you are looking at. There are plenty of different markets, but in this article, we focus on the stock market.

How to invest in a bear market

This blog is mostly about trading, but we happen to be long-term investors as well, so we’d briefly like to mention what is the most rational thing to do if you’re an investor and find out you’re experiencing a bear market:

Keep on investing. If you’re a long-term buyer and have many years left until retirement/withdrawal, you should be happy for a bear market where you can buy at lower prices. Sure, it can continue falling, but you’ll not manage to pick a bottom, but that should not worry you.

Stocks have proven to be a good inflation hedge for the long term with positive real returns.

Should you fear a bear market?

As you’ll learn in this article, you should not fear a bear market. We’ll now go through some steps that make you prepared for a bear market. When the bear market one day comes around, you have nothing to fear (fear in trading).

How to make money in a bear market – 2 steps

We’ll now go through two simple steps that make you well-prepared for the next bear market:

Step1: Backtest in both bull and bear markets

In our opinion, the key is to backtest your trading strategies with strict trading rules and settings so you are completely aware of the historical performance and statistics. Many traders don’t have a trading edge in the first place, and they simply trade a trading idea that is based on anecdotal evidence.

Second, you need to backtest through various business cycles. The years from 2010 until 2022 have been a very long bullish cycle that was fueled by money printing, quantitative easing, and in some parts of the world even negative nominal interest rates. This is unlikely to continue endlessly, as 2022 proved.

Step 2: Trade both from the long and short side

If you’re a stock trader, you probably know why short-selling is difficult. Most of the time, shorting is just a money-wasting exercise. But in a bear market, short strategies start working. Thus, make sure you are prepared and have a few short strategies at hand.

Below is a backtest of a strategy that trades S&P 500 (SPY) using both market directions with identical (but opposite) trading signals:

How to make money in bear markets

The trading performance metrics for short are pretty good (but even better for long trades):

How to make money in bear markets backtest

This strategy trades only short when there is a bear market, and as you can see, the average gain per trade is pretty good.

The strategy will be presented as a monthly trading edge later:

That’s it. Two simple steps that will make sure you are prepared for the next bear market!

What works in a bear market? Can you get rich in a bear market? Strategy backtest

We have established that short trades historically have worked in a bear market, but the icing on the cake is that long trades also (often) improve.

Yes, that’s right, you read it correctly. Long trades tend to improve in a bear market! At least in the stock market.

How is that possible?

The best strategies can be found in our….

Strategy Shop

Backtested trading strategies

We believe the main reason is that many short sellers need to cover their positions, and this leads to very potent bear market rallies (dead cat bounce?).

We have covered short selling in multiple articles earlier and we recommend reading the articles below to make you a better trader:

To “prove” that long has worked well in bear markets in the past, we backtest ATR swing trade on QQQ. This is a long-only strategy backtested on QQQ, the ETF that tracks Nasdaq 100. Here’s the equity curve of the strategy:

How to make money in bear market (trading rules)

It shows pretty consistent performance in both bull and bear markets. The strategy was made almost ten years ago and it has 16 months of out-of sample data since it was published to our monthly trading edges subscribers.

Let’s look more in detail at the numbers for the strategy:

What works in a bear market?

The lower section of the table above clearly indicates that this is a very robust strategy:

The strategy has made 13.28% annually but is only invested 11.29% of the time. It has “crushed” the buy and hold which only has a CAGR (what is CAGR?) of 5.33%.

The main reason for the outperformance is that the strategy performs extremely well during bear markets (even though it only takes long trades).

Let’s look at the annual returns of the strategy:

Backtest in both bull and bear markets

The most interesting years are 2000, 2001, 2002, 2003, 2008, 2018, and 2022. Those years were negative for the overall stock market and spent some time under the 200-day moving average (and thus are bear markets).

Let’s dig deeper and summarize the difference between the strategy and the performance of buying and holding Nasdaq:

YearStrategyNasdaq %Difference %
2000120-39.3159.3
200119.5-21.0540.55
200247-31.5378.53
20039.250.01-40.81
20044.28.59-4.39
2005-0.21.37-1.57
20066.99.52-2.62
20073.39.81-6.51
200814-40.5454.54
200921.443.89-22.49
20106.816.91-10.11
20116.6-1.88.4
20122.715.91-13.21
20139.938.32-28.42
201412.113.4-1.3
20155.95.730.17
20164.87.5-2.7
20174.628.54-23.94
20187.1-3.8810.98
20191.335.23-33.93
202020.143.64-23.54
202111.921.39-9.49
20225.3-28.633.9

What can we conclude from the historical performance? Our strategy is firing on all cylinders during bear markets, but will most likely underperform in a roaring bull market (yet outperform over the long term).

Let’s explain why we believe the strategy has potential to outperform in the long run:

Let’s look at 2008: our strategy is up 14% while Nasdaq is down 40.54%. This is significant. Why? Because you can compound from a much higher level when 2009 starts. Let’s make an example:

You have 100 000 invested at the beginning of 2008. You make 14% on the strategy and have 114 000 at the end of the year. If you bought Nasdaq, you would only have 59 460 at the end of the year.

Next year, in 2009, the strategy underperforms (21.4% vs Nasdaq’s 43.89%). You would have 138 396 at the end of 2009. While Nasdaq rises 43.89% in 2009, you still end up with only 85 556 at the end of the year because you started with a substantially lower base because of the dreadful 2008. This shows that compounding efficiently (and avoiding ruin) is just as much about not losing money!

The strategy’s performance shows the magic of compounding, avoiding risk/losses, and the sequence of returns. You need to preserve your capital!

If you want to delve further into sequence risk and ruin, we recommend the following articles:

Bear market trading and investing strategies

We have provided plenty of different strategies on this blog. We even have many free strategies – please look at our list of trading strategies. However, we keep our best strategies for our paying subscribers:

How to make money in a bear market crypto

Crypto has become popular, but we assume the interest drops together with the prices in the crypto market.

We have presented a few crypto strategies during the last couple of years, and several have held up pretty well because they are trend-following strategies.

What to do in a bear market?

If you have read so far, it should be obvious what you should do in a bear market: absolutely nothing (if you are prepared). You should continue pushing your buttons and continue trading your systems. That’s the most rational thing to do. Ignore the pessimistic news.

How do bears make money?

You shouldn’t be a bear or a bull. Good traders are not opinionated. Instead, they are adaptable, flexible, and have a clear-cut trading plan.

Is it good to buy in a bear market?

Yes, exactly as our backtest indicates, but given that you have a valid and backtested trading strategy.

Also, if you are a long-term investor, a bear market might give you some nice opportunities to buy quality companies on the cheap. If you’re a net long-term buyer in the future, for example if you’re dollar-cost averaging, you should welcome a bear market.

Unfortunately, many investors have it completely upside down: they are happy when they see rising prices and keep on buying. When the bear market arrives, they stop buying.

If you are a future buyer you would want lower prices, not higher ones!

Research shows that women are better long-term investors than men. The reason is simple: they buy every month or at specific intervals, and they forget about it. They are not trying to be smart.

How to make money in a bear market – summary

Our main point to get across with this article is the following:

If you have a backtested short-term trading strategy that has performed well in past bear markets, then continue trading through the bear market. Don’t start fiddling with your strategy based on short-term data or fear. Also, if you have short strategies, they normally perform well in volatile and falling markets.

If you are a long-term net buyer of stocks in the future, continue buying.

A bear market is an opportunity, not something to fear. A good idea might be to avoid reading news during a bear market as it might make you deviate from your plan on how to make money in a bear market.

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