Are We Even In A Bear Market?

Today is Sunday, August 28th 2011 and there is an ongoing debate amongst financial journalists, analysts and traders as to whether or not we are in a bear market. My view is that since we are under the 200 day moving average, it’s pretty easy to say that we are indeed in a fresh bear market, but others beg to differ. That’s fine with me, and I’m not about to get into an argument with anyone over whether or not we are in a bear market or not, but we are sure acting like we are, so I figured, why not learn a little about trading them?

There are a few definitions of what makes a bear market.  The most recent one I read as I was writing this article is a decline of 20% in the major indexes that persists for many months.  Super!  So does that mean we have to wait for a few months before we can determine that we are actually in a bear market? In my opinion, it’s time to trade like we are in one, because if we move back above the 200 day moving average (my line in the sand) and out of it, it’s easy enough to switch gears.

Trading A Bear Market Is Different Than Trading A Bull Market

Trading a bear market is not as simple as many make it out to be.  It surely is not just the inverse of trading a bull market, as the stock market trends that exist during a bear market are different.  Adjustments are needed in order to not only survive, but to actually prosper during a bear market.  While most people are ducking for cover, picking up some of the character traits of a bear market can be extremely helpful in writing out your trading business plan.  For example:  did you know that the biggest one day rallies in the Dow have all been during a bear market?  This sounds counter intuitive, but as you continue to read on, you will see why it makes perfect sense.

Bull markets tend to move in a more linear, controlled fashion, allowing technicians a fantastic opportunity to follow the stock market trends as they unfold.  Bear markets on the other hand, will have more random moves that bust traditional setups and can drive chart readers as well as fundamental traders up a wall. While trading a bull market is not as easy as some of the super gurus will lead you to believe, it can be more predictable, and not just becasue as some like to say “the market always eventually goes back up”.  How many days exactly are in an eventually? The reason a bear market is harder to trade is that it brings with it pockets of volatility, which correlates in the financial markets with downside price movement.  This increase in volatility can shake traders out more often than usual, which leads to frustration, in turn leading you to over trade and make impulsive decisions, rather than sticking with your well thought out trading business plan. Any time you are trading purely on an emotion such as revenge, it raises the risk of ruin danger level in your trading business significantly.

While volatility does bring opportunity, it also brings increased risk, and can do serious damage to your trading account if you do not take the time and care to adjust your trading plan.  Range tends to expand, and volume increases during volatile times.  Overshoots of support and resistance lead to many whipsaws occurring, and a lack of adjustment to this will leave you scratching your head as to why you just took a much more serious drawdown in your account than you had anticipated.

Making The Bear Market Adjustments

While it’s always vitally important to keep risk at the forefront of your trading plan, when the volatility increases as we enter a bear market, it becomes the only thing that matters. Short covering rallies can start with a snap back, and leave your swing positions choking on the dust of anxious buyers looking to pick the bottom and get the low of a new bull market.  Then, just when it looks like a bottom could be in, and the market seems to be getting away from you, it comes slicing back down, trapping any late comers and their long side exposure. This is common price action in a bear market, and should not be brushed aside as just typical action in the market.

 I’m not a fan of sitting on the sideline until things get “better”, because who knows how long a bear market will last, and who says things aren’t better in a bear market? While there is no red light green light version of knowing when volatility is in unsafe mode, there is one filter I like to use, and that’s the $VIX.  When the $VIX is above the 30 handle and its 10 day moving average, it is showing a sign of increased volatility, and suggests that overnight exposure carries greater risk.  This allows swing traders to make their adjustments in size and keep things at the same risk that they normally take.  It also allows day traders to pinpoint periods where they need to reduce their size due to an increase in frequency.  The true pros will understand that more trades equate to a bigger chance of a streak of losers, and ramping size only puts them in front of the bull’s-eye.

Whether the bear market is here or not, the increase in volatility is definitely here, and could be for a while.  Adjusting your trading plan to accomodate this will lead to reduced exposure and allow you to sleep at night.  In a bull or bear market, that’s always a good thing.

Trade well,

Michael tiny Saul

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