Bear market trading: how to invest in and trade falling markets

12 strategies investors and traders use when prices are falling

1. Take a short-selling position
2. Find a good entry position
3. Dollar-Cost Averaging
4. Trade the VIX
5. Trade indices and ETFs
6. Diversify your holdings
7. Focus on the long-term
8. Trade safe-haven assets
9. Trade currencies
10. Choose high-yielding dividend shares
11. Trade options
12. Buy at the bottom

Take a short-selling position

Going short in bearish times is one of the most common bear market strategies among traders. As a trader, you’ll short-sell when you expect a market’s price will fall. If you predict this correctly and the market you’re trading on does decline in value, you’ll make a profit. If the price rises instead, you’ll make a loss.

Shorting can be done via CFD trading with us. CFDs let you speculate on price movements without taking ownership of the underlying asset. They’re also leveraged, meaning you’ll only need to put up a small initial deposit (called margin) to open a larger position. However, leveraged trades are inherently risky, as both profits and losses are calculated on the total position size, not your margin amount.

Also, short positions can in theory incur unlimited losses if the underlying stock appreciates in price instead of falls. This is because there’s no limit to how high a market can rise. This, plus leverage, means having a risk management strategy in place is crucial. Part of this means attaching stops to your positions.

There are many ways to short, depending on which market you want to trade.

Indices – going short on indices is a common way to trade in bearish times, as these track major global stock markets like the FTSE 100 and S&P 500 and enable you to track the price movements of an entire index in one go.

This means it could be less risky than putting all eggs in one basket by taking a position against one stock. Shorting major indices comes with low spreads and is the only way to speculate on the real index price directly. Plus, with us, you can short key indices 24/7, including at the weekend.¹

Shares – you might short-sell shares if you think an individual stock has further to fall in a downturn. Let’s say you think rising interest rates spell bad news for the technology sector. You might short a tech stock that you think is exposed to this downside. If you predict a drop in price correctly, you’ll make a profit off your position.

ETFs – like indices, ETFs give you the opportunity to go short across a number of stocks all at once. An ETF’s exposure can span an index or a whole sector or industry. Going back to the tech sector example, ETFs might enable you to spread risk by shorting a tech ETF that tracks multiple stocks rather than shorting just the one.

If you’re looking to short an index specifically, indices trading might be better for you. That's because the price will be based on the real underlying index price (unlike ETFs) and there are likely to be lower spreads.

Commodities – you can go short on the price of commodities like oil, gold or silver. For example, you may believe supply is going to outstrip demand for soybeans in the near future. So you’d decide to short the price of soybeans. If you’re correct and the commodity’s price falls, you’ll make a profit.

Pros and cons of going short:

• There’s a potential to make a profit by shorting, as it means you can make money if prices fall
• You can, however, also make a loss. Since there’s no limit to how high asset prices can climb, your potential for loss when going short is also theoretically unlimited
• When you short-sell with us, you’ll use CFDs which are leveraged. This means you can open a larger position with a smaller amount of capital (called margin) as an initial outlay
• However, leveraged trades mean a greater potential for larger profits and losses, since CFDs are calculated on your position size and not your margin amount
• If you have gone long or invested with other positions, going short enables you to hedge in a bearish market

Find an entry position

In any sort of market, finding the right entry position for you – the exact point at which to open your position – can make or break a trade or investment.

This is especially true of bear markets. Opening your position at the exact right moment during a downturn creates opportunities for traders to go short and make a profit if they speculate correctly. For investors, it can also mean purchasing shares or ETFs at a lower prices than they might get in a bull run.

On the other hand, bearish climates are ones when underlying assets’ prices can rapidly fall, sentiment may be negative and volatility often spikes. This means greater risk of bigger losses, fast – but also means potential for profit. Hence an effective risk management strategy, with stops on your positions, is all the more important.

Traders and investors may also use technical analysis to determine the best entry position for them.

Dollar-cost averaging

A strategy some investors use during depressed markets is dollar-cost averaging. This means you’ll schedule a series of small investments over the long term, regardless of the economic climate at any given time, which will smooth and balance out the volatility of a bear market eventually.

During bearish times, you may be tempted to buy more of a stock you’re interested in, given its lower price thanks to the market. However, this can be risky too. It requires perfect timing of the market in order to truly be profitable and has a high probability of ending in loss if you haven’t timed correctly.

With dollar-cost averaging, you’d continue investing the same amount consistently over the long term. This removes emotion from the equation, because you’ll be investing no matter what state the market’s in.

You’ll also likely capture the average return of the market, because you’ll be buying regularly – when prices are high, low and everything in between. This means that, over time, you could end up with a larger investment position than if you only bought into the market once or twice a year.

Trade the VIX

A useful index to keep an eye on during downturns is the VIX (volatility index).² Because the VIX charts volatility in the market, it’s a good indicator for trader and investor sentiment. When bear markets cause panic, pessimism and sudden sell-offs, the VIX is often one of the first gauges to predict it.

While some investors and traders watch the VIX only, others will actively speculate on it. The VIX often exhibits negative correlation between it and other indices and stocks – meaning that when other assets’ prices are going down, the VIX is likely to go up.

This means the VIX is a popular choice among traders and investors for diversification and hedging one’s market exposure – two very effective strategies for bear markets.

Trade indices and ETFs

The VIX is only one avenue traders use during a bear run. You can also trade many other indices and ETFs, which is a popular strategy when markets are trending downward. That’s because both give you broad exposure to a whole group of stocks all at once, enabling you to speculate on them directly.

For example, you can trade directly on indices like the FTSE 100 to gain exposure to all 100 of the top companies in the UK with one position.

ETFs encompass an entire basket of shares, often representing an entire industry or sector as a whole. They also fall into the category of ‘thematic investing’ – for example, you can trade cannabis stocks on the whole as a theme.

Additionally, you also get short exchange traded funds, also known as inverse ETFs, which are designed to profit when the underlying benchmark declines. These are similar to shorting a security, except instead of borrowing an asset to sell, you're buying the market. So, inverse ETFs enable investors to profit in a downward market, without having to short-sell anything.

Both indices and ETFs are ways to diversify your portfolio during a bear market. Generally, the more different types of assets you have or trade during a bearish time, the more they’ll help you manage risk by hedging your exposure to any one market.

Diversify your holdings

This brings us onto an often underestimated, but very well-known strategy to remember during bear markets – diversity is your friend.

Both investors and traders can diversify by keeping open various positions of completely different asset classes. If your portfolio is made up of asset classes that behave differently to one another and do well (or poorly) in opposing market conditions, you’ll always have something performing well, softening the risk of other underlying assets underperforming.

For example, the S&P 500, known as the US 500 on our platform, may go down during a bear market, but some of the companies within the index may not. So, instead of only trading on the S&P itself, you could target specific high-paying dividend stocks. Or, you could even trade on bonds where prices often move in the opposite direction of stock prices.

The more diffused your risk is during unpredictable times – like bear markets – the better you’ll be able to weather the storm, most of the time.

Focus on the long term

Like bears themselves, one of the strategies to employ during downturns is to hunker down and wait out the winter.

This is because of the cyclical nature of markets. While bearish periods are difficult to endure, history shows you probably won’t have to wait too long for the market to recover. Bear markets are followed by bullish rallies – always – and often upswings occur sooner rather than later.

The 2019 to 2021 market was a good example of this. Before the Covid-19 pandemic downturn, we’d experienced the longest bull run in history, spanning nearly 11 years.

Find out how to trade bull markets

It may also be heartening to remember that, if you’re investing for a long-term goal such as retirement, the bear markets you’ll endure over the years will be overshadowed by bull markets.

Trade 'safe-haven' assets

It makes sense to look for a harbour of refuge in stormy economic climes. For many traders, that’s 'safe-haven' assets.

These are markets that tend to retain or increase in value during volatile times when many asset classes do poorly. This is often because they’re negatively correlated with the economy.

The most shining (and famous) example of a safe haven asset is gold, but there are others too. These include government bonds, the US dollar, the Japanese yen and Swiss franc.

However, it’s important to remember that, just because an asset is traditionally considered a 'safe haven', it doesn’t guarantee it’ll be one in every bearish market.

Choose high-yielding dividend shares

If you’re an investor, finding dividend stocks that are known for generous payouts can be a great way to get a passive income during a declining market. The great thing above high dividend payers is that they’ve got a reputation to uphold.

While the company’s share price might take a hit, they’ll still likely pay higher dividends than most other businesses in order to retain and attract investors.

The trick here is ensuring you’re buying shares in dividend stocks that are sustainable. Once you’ve identified a dividend stock, you can either invest with our stock trading service or speculate on the company’s share price by opening a CFD trading account.