Derivatives Trading in Bear Markets

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James Blawn

How can CFD trading techniques assist when markets are getting ‘bear-mauled’ from every direction? Find out which trading strategies can assist in down markets.

Maximizing Downside Trends with Effective Trading Strategies

Source: Pixabay No Attribution Required

 

Preface: Global stock markets are in a pitiful state. The Dow Jones Industrial Average, the S&P 500 Index, the NASDAQ Composite Index, the New York Stock Exchange Composite Index, and the S&P/TSX Composite Index are all markedly down for 2020. From multigenerational highs, the Dow Jones has sunk to the 20,900 level, the NASDAQ to 7300, and the S&P 500 index to 2470 and thereabouts. These levels are double-digit points down for Q1 2020, and the prognosis heading into Q2 2020 is equally grim.

 

CNN reported a 3000% jump in jobless claims to date this year. Dubbed ‘…one of the most devastating periods in the history of the country,’ businesses in every major industry are shedding workers at a furious pace. For the week ending March 28, 2020, some 6.648 million workers filed for unemployment benefits (Dept. of Labor), accelerating rampant declines in demand, discretionary spending, productivity, and general economic activity.

The last 14 days of March resulted in some 10 million Americans out of jobs, or 6% of the workforce. This has pushed the unemployment rate towards 10%, and rising fast. With such a grim prognosis, it’s only natural to ask how traders and investors are working the markets to prevent further degradation of their financial holdings, investments, and retirement funds.

 

Source: US Dept of Labor graphic by CNN (Annalyn Kurtz and Tal Yellin)

 

These figures paint a dark picture of what the economy is likely to endure as the pandemic worsens. While New York bears the brunt of the coronavirus, with thousands dead and countless others infected, each of the other states is readying for an Armageddon-style scenario as the virus sweeps across the nation. Companies across the country are shuttering operations, either by way of governors’ decrees, or national lockdown orders.

 

Economic activity has cratered. The oil price has collapsed to $20 per barrel for WTI crude oil and $25 per barrel for Brent crude oil, with no end in sight. The Fed has injected a $2 trillion plus stimulus into the economy, hoping to reignite economic activity, but this will take a substantial amount of time to get going. For now, the short-term focus is on salvaging whatever is left of financial portfolios, preventing further degradation thereof, and making smart decisions via effective trading strategies.

 

Short-Selling as a Viable Trading Strategy?

 

When markets start tanking, short sellers start cashing in. Falling prices are just as common as rising prices vis-a-vis financial instruments like stocks, commodities, indices, currencies, and contrarian asset categories. Bear markets now characterize the trading landscape. A bear market is official when there has been a 20% + decline from a previous high, lasting for a period of 2+ months. While the coronavirus has not impacted global financial markets for much more than 2 months to date, the fallout from the pandemic will last many months more than that. We are already 30% down from the Dow’s high in 2020, and a few more weeks of the status quo will validate the definition of a bear market.

 

It is clear that sellers outweigh buyers by a long margin. Only the institutional buyers and a handful of savvy investors are buying on the dip, everyone else is too scared to move. The current state of the market is significantly different to a correction, a reversal, or a pullback. What we are seeing now is a global short-to-medium-term selloff. It is a collapse in supply and a collapse in demand. Companies are closing up their doors from China to Hawaii, from Australia to South Africa, as government lockdowns take effect. These short-term initiatives are designed to slow the spread of the pandemic, but the effect on economic activity will linger for a long time. In fact, there are real concerns that COVID-19 will lead to recession or depression.

 

Trading experts advise against following the herd. When everybody is selling, there is little to be gained by selling along with them. Investors believe that if they don’t sell when everyone else is selling, the price of their investments will drop further. This results in an accelerated sell-off of equities, indices, commodities, and even currencies, much to the detriment of the seller. Then there are the buy and hold investors who are not perturbed by the sudden and dramatic turbulence that hits the markets. Fortunately, there are trading strategies to employ that can mitigate the effects. These include diversifying your portfolio away from high-risk, high volatile stocks towards low-risk, low volatility asset holdings.

 

It Is Possible To Profit When Markets Are Upside down

Source: Dow Jones Industrial Average

 

During a bear market, there are a variety of tools at your disposal to lessen the overall risk to your portfolio. These include shifting from stocks to safe-haven assets such as gold. It should be borne in mind that there isn’t necessarily a direct correlation between a poorly performing stock market, and a rampant run on gold. Gold stocks such as SPDR are managed by companies, notably big banks, whose interest is maximizing their own profitability and not those of investors. SPDR is the world’s largest exchange traded gold fund with massive holdings of physical gold bullion. A switch to an alternative asset class with the express objective of mitigating downside risk is known as hedging. SPDR has risen much more conservatively than the general stock market has plunged.

 

Most of the strategies that traders use during bear markets are short-sell orders. There are short ETFs, short-selling of financial instruments, and buying on the dip. These and many other strategies are employed to great effect by strategic traders around the world. While every trader seeks that panacea to the ill-fated bear market, there really is no effective strategy to guarantee favorable returns in any market. Some of the best strategies employed by traders are simply known as risk-mitigation or damage control.

 

Traders understand that markets cannot rise indefinitely; upturns and downturns are part of the free market system. Even in a market downturn, the path is never linear – there are upswings and downswings in bear markets too. By analyzing the market, it is possible to implement bear market plans. Short-selling is a powerful tool in your arsenal when combating bear markets. Contracts for difference, or CFDs, allow you to trade assets based on price movements alone – without taking ownership of the underlying asset. Since leverage is a play, it is possible to bet against a financial instrument and profit to the upside, even in a down-market.

 

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