Bear market trading: how to trade falling markets

9 strategies traders use when prices are falling

1. Take a short-selling position
2. Find a good entry position
3. Trade the VIX
4. Trade indices and ETFs
5. Diversify your holdings
6. Focus on the long term
7. Trade safe-haven assets
8. Trade currencies
9. Trade options

Take a short-selling position

Going short is one of the most common strategies among traders in bearish times. As a trader, you’ll short-sell when you expect a market’s price to fall. If 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.

With us, you can short-sell using contracts for difference (CFDs). CFDs enable you to take a position on price movements without taking ownership of the underlying asset. They’re 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.

Because there’s no limit to how high a market can go, short positions can – in theory – incur unlimited losses if the price of the underlying asset rises rather than falls. 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 go short, depending on which market you want to trade.

Indices – going short on these instruments is a common way to trade in bearish times. That’s because indices like the FTSE 100 and US 500 track major global stock markets. They also enable you to predict on the performance of an entire group of stocks in a single trade, which could be less risky than putting all your eggs in one basket by betting against just one stock. What’s more, you can short key indices 24 hours a day using our CFD offering.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 the market then behaved as you predicted it would, you’d make a profit off your position.

ETFs – like indices, ETFs give you the opportunity to go short on a number of stocks at once. An ETF’s exposure can span an index, or a whole sector or industry. Going back to the tech sector example, you could short an entire basket of tech stocks through an ETF – potentially spreading your risk – rather than shorting just one such stock.

If you’re looking to short an index specifically, indices trading might be better for you because it’s likely to be the more cost-effective option.

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 price does actually fall, you’ll profit.

Pros and cons of going short:

• You can make money if you go short and prices fall
• You can, however, also make a loss. And, since there’s no limit to how high asset prices can climb, your potential for loss when going short is theoretically unlimited
• With us, you’ll short-sell with leverage using CFDs. This means you can open a larger position with a smaller amount of capital (called margin) as an initial outlay
• Leveraged trades mean greater potential for larger profits and losses, since both are calculated on your full position size and not your margin amount
• If you’ve gone long with other positions, going short enables you to hedge in a bearish market

Find a good entry position

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

This is especially true for bear markets. Opening a position at exactly the right moment during a downturn creates opportunities for traders to go short and make a profit if their predictions are correct.

However, because bearish climates are ones where rapidly falling prices, negative sentiment and spikes in volatility can be seen, there’s a faster and greater risk of bigger losses. That’s what makes having an effective risk management strategy with stops on your positions all the more important.

Most experienced traders use technical analysis to determine the best entry position for them.

Discover strategies for finding your best entry position

Trade the VIX

A useful index to keep an eye on during downturns is the VIX (volatility index). The VIX tracks market volatility and, as such, can be one of the first indicators to show that a bearish downturn is approaching.

While some traders only monitor the VIX, others will actively take a position on it. The VIX typically has a negative correlation with other indices and stocks – meaning that when the prices of other assets are going down, the VIX is likely to go up.

This makes it a popular choice among traders for diversifying and hedging their exposure – both of which are helpful in bear markets.

Trade indices and ETFs

The VIX is just one avenue you can 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 exposure to a whole group of stocks all at once, enabling you to predict on them directly.

ETFs encompass an entire basket of shares, often representing an industry or a 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.

In addition to regular ETFs, you can take a position on short or 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 traders 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 types of assets you have or trade during a bearish time, the more you can manage risk by hedging your exposure to any one market.

Diversify your holdings

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

Traders can diversify by holding various positions in completely different asset classes. While by no means a foolproof strategy, diversification can help reduce the risk you might face if you had exposure to just one or a few asset classes.

For example, the US 500 may fall during a bear market, but some of its constituent companies may not. So, instead of only trading the index itself, you could target specific high-paying dividend stocks. Or you could even trade 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.

Learn how to diversify as a trader

Focus on the long term

One of the strategies that traders can use during downturns is to, like bears themselves, 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 upswings often occur sooner rather than later.

Find out how to trade bull markets

Trade safe-haven assets

It makes sense to look for refuge in stormy economic climes. For many traders, that refuge is safe-haven assets.

Safe-haven assets are those that tend to retain or increase in value during volatile times when many others do poorly. This is often because they’re negatively correlated with the economy.

The most famous example of a safe-haven asset is gold, but there are others – like government bonds, the US dollar, the Japanese yen and the Swiss franc.

However, it’s important to remember that – even with assets that are traditionally considered safe havens – your chances of making a profit in a bearish market aren’t guaranteed.

Trade options

Trading options contracts, commonly known as options, gives you the right – but not the obligation – to buy or sell an underlying asset at a specific price by a set point of expiry. This means that you can choose not to exercise this right if you want.

Two common options strategies for hard times are:

1. Buying put options
2. Writing covered calls

When you buy a put option on a stock, you’d do so believing that the company’s share price will drop in value. If the share price fell or stayed the same, you’d make a profit. This is different to going short with normal derivatives trading such as CFD trading, where you’d only make a profit if the share price dropped.

This can be less risky than traditional short-selling because, should markets suddenly turn more optimistic, you can just let an option expire without incurring any costs.

Writing covered calls is another trading strategy that could be useful in a neutral to bearish market. This strategy involves selling a call option against a stock that you already own. In other words, you agree to sell the stock you own to the holder of a call option. If the holder (ie buyer) chooses to exercise the option, you’ll sell the stock at the specified price.

If you were already planning on selling your stock, this strategy could provide a way for you to profit from that sale – even with the market in decline.