Last Updated on 15 January, 2025 by Trading System
Day trading on its own comes with many challenges, even in raging bull markets. Finding profitable day trading setups is hard in most market conditions, and the low timeframes introduce a lot of market noise that easily could occlude your view. So how do you day trade in a bear market?
In this guide, we’ll show you some valuable tips that we hope will make it easier to transition from a bull market to a bear market. In addition, you’ll learn:
- Why daytrading is so hard, and how it becomes even harder in a bear market
- The steps many day traders take as a bear market approaches
- How you can be better prepared to stand out as a winner once the bear market strikes!
Although bear markets may seem intimidating, it’s the perfect opportunity for somebody with a reliable strategy to up their game. The irrationality of market players gives rise to many profitable trading setups, which can be taken advantage of with the right strategy and risk management techniques!
With this said, let’s look at what makes daytrading hard in the first place.
Why Day Trading Is hard Even in a Bull market
Before we look into how to day trade in a bear market, it might be good to understand the basics behind why day trading is so hard in the first place. This will make it easier to understand how a bear market impacts day trading on a general level.
Here are the four biggest factors:
Most returns happen over-night
One of the reasons why most people only go long in the stock market, is the bullish bias of the market. Over time, stocks and equities appreciate, which means that those who take long positions will get a lot for free.
Now, one thing that many people don’t know, is that the bullish drive actually is made up of positive over-night gaps, rather than intraday movements. If we look at the chart below, taken from New York Times, we see that regular hours, which represent the daily session, have produced no returns whatsoever, while nightly returns have been great!
This is one of the reasons why it’s so much easier to pursue swing trading than daytrading. Swing traders simply have the bullish drive of the market holding their back, meaning that the expected outcome of a couple of random trades would be positive! The same does not apply to daytrading, where you could roughly say that the expected outcome of a couple of random trades would be roughly breakeven. However, that’s without taking transactional costs into account, which is the next reason on the list.
Transactional Costs
As a day trader, the size of your trades is going be relatively small, which isn’t that strange considering that you hold on to your trades for a relatively short time period.
However, the result becomes that transactional costs like slippage and commissions quite easily could eat into your profits. In fact, many trading strategies, although profitable when looking strictly at a backtest, may not work out when all the costs have been accounted for.
Psychological Aspect
Daytrading indeed is one of the more psychologically demanding trading forms. It’s not easy to enter a position and watch the market go against you, knowing that you have to remain in the trade to make use of your edge. As we’ll see soon, bear markets tend to make this even more difficult…
Market Noise
Day traders usually use smaller timeframes like 5 or 15-minute charts to analyze the market. While this allows for a more detailed view of the market’s moves, it also introduces a lot of market noise, which we need to learn to see through.
As you see, there are many factors that play a part in making day trading a difficult trading form.
With this covered, let’s briefly look at what a bear market is and its main characteristics.
What Is a Bear Market?
Here is the short definition:
A bear market is when the market falls 20% or more from it’s highest point, which signals pessimism and a negative view among most market participants. Most times, the market is defined as one of the bigger equity indexes, such as the S&P-500. However, individual stocks can be in bear markets on their own, if they meet the previously mentioned conditions, even if the negative market sentiment won’t be as widespread and unforgiving as when the stock market as a whole goes through a bear market.
Why does a bear market occur in the first place?
As with most things pertaining to finance and trading, there will be a lot of different factors that lead to bear markets. To keep it very simply, you could say that bear markets happen due to events or information that make people assume that the current evaluation of stocks are too high in relation to their future performance.
Some of the reasons behind bear markets in the past have been:
- The implosion of some sectors or parts of the economy
- Loan bubbles
- Monetary policy and conditions
- Changes in yield curves.
Does Day Trading Still Work In Bear Markets?
This really is the question most people are looking to find an answer to. Here is the short answer:
Day trading does work in bear markets, and for some even better than in a bull market. This, again, has to do with the increase in volatility and irrational decisions made by market players, which leads to a lot of exciting trading opportunities.
This is something we see ourselves with our own trading strategies. For instance, during the market turmoil related to the coronavirus in 2020, many of our daytrading strategies spiked as a result of the extreme increases in market volatility!
Now, some strategies will, of course, fail miserably, but with robust and correctly vetted strategies, a bear market could be incredibly profitable.
The Best Ways to Approach a Bear Market
Having covered the basics, let’s now look at three concrete approaches to day trading in bear markets, that are commonly used by day traders. The approach that’s right for you depends on personal preferences, as well as on how much you trust your trading strategies. We’ll try to make it clearer for you below!
1. Staying in cash
The first option is to just not day trade, and let your trading capital rest some time. There is nothing wrong with staying out of the market at times when you’re unsure of what to do. It could be that you aren’t confident enough in the strategies you trade, or find it too difficult emotionally to enter a market that’s in free fall.
If you decide to not trade, set a future date when you’ll consider starting again. Many traders continue to monitor their systems and expose themselves to a lot of unnecessary angst, as they see their strategies rebound and make new equity highs. And even worse, they may be tempted to pick random trades to make up for their losses.
If you just pick a date and decide to not regard any trades that were placed as missed opportunities, you’ll save yourself from a lot of emotional turmoil!
2. Requiring more to take a trade
Many people who trade daytrading strategies that only go long might trust their strategies enough to keep using them in a bear market, but may still feel inclined to cancel their trading. As we’ve already mentioned, this is a perfectly reasonable and sensible decision to make. However, if you’d like to keep trading but still risk a little less, instead, you could choose to only act on those signals that are the most likely to work out well.
For example, if you trade a day trading strategy that is based on mean reversion, you could increase the distance the market needs fall to trigger a signal. In another scenario where you’re trading a breakout strategy and know that the edge gets stronger the more volatile the breakout is, you could demand a higher ADX value than normally, just to name one example.
So, in short, it’s all about reducing the number of trades you take to only those that have the highest probability of working out well. While it’s likely that it will lead to smaller gains on the end row, the hit-ratio and profit factor of the trades that remain will hopefully be much better
3. Short Selling
Some people will choose to go heavier on the short side to profit from the big and sudden falls that characterize bear markets. However, there are some incredibly important things you should be aware of when it comes to going short in bear markets.
- When stocks fall quickly and the bearish forces seem unrelenting, it’s not uncommon to see new restrictions on short selling. They’re imposed to alleviate the negative effects that massive waves of short orders would have on the price of the security.
- As we’ve already mentioned a couple of times, bear markets move fast, both to the upside and downside. As such, you should be careful and monitor your positions carefully.
Shorting the stock market is not something that should be attempted by a beginner. In addition to the challenges above, you also face the risk of massive overnight gaps if you for some reason don’t succeed to get out of your position in time, and the danger of having losses that exceed the amount you went in with.
4. Reduce Your Position Size
If you’re feeling unsure of whether your strategy will be able to withstand the coming bear market and don’t want to stop trading completely, you could simply reduce your position size. That way your account will be affected less by big losing trades, while you’re still in the game.
Another key benefit of this approach is that you very likely will reduce your emotional stress level, which will help in making good and well thought through decisions.
In general, reducing your position size is a great approach when you get into uncharted territory that might require some testing for you to fully trust your methods.
How to Ensure that a Day Trading Strategy Will Last in a Bear Market
In order to become a successful day trader, you must trust your strategies enough to feel confident when placing trading in varying market conditions.
One big issue with many day trading strategies is that they have only been tested and validated during very bullish periods. Even if you use longer periods with market data to validate and backtest your strategy, it may be that you don’t get far back enough to get enough bearish market conditions for your backtest. As a result, you can be much less certain about how the strategy is going to deal with future bearish market phases.
By making sure that your strategy has been working and survived through previous market crashes, it’s more likely that they will continue to deliver profits also in future bear markets.
Our article on backtesting deals with this topic in greater depth!
Final Tips for Day Trading in a Bear Market
Let’s now round off this article with two tips that we think will help a lot!
Make sure to manage your drawdowns correctly!
Unfortunately, a lot of day traders haven’t got a realistic view of their risk tolerance before starting to trade, and expect everything to get sorted out as soon as they start trading live. The thing is that it’s very hard to assess the emotional impact trading in conditions may have on you.
Therefore you should always make sure to not take on too much risk, to ensure that you can
Continue to follow your strategies!
During times of crisis and market turmoil, you should be prepared for the ominous and disastrous headlines that fill up the front pages of most papers and magazines. In short, you could say that we’re the most pessimistic when we reach the market bottom, which also is reflected in the adage “buy when there’s blood in the streets”. In other words, historically, those who have done as is in line with the current sentiment reflected in newspaper headlines, have done the very opposite of what would have given the best results.
Never let the headlines of news magazines have an immediate impact on your decisions. Of course, it’s prudent to weigh in the opinion of experts, but you should still strive to follow your strategy, which is what will ensure profits in the long run!
Conclusion
Day trading indeed is a hard trading style, and it doesn’t get much easier having to carry out the trades in a bear market.
Still, the quick movements and heightened volatility levels often mark the perfect opportunity to make a lot of money, provided that you have a vetted and well-tested trading strategy.
Just remember to not let the ominous headlines in the news have too much of an impact on you. Remembering that news coverage is in its most negative state as the bear market draws to and end, could make it easier to follow through with your trading plan!
Those of you who want to learn more about building and testing trading strategies, are recommended the following articles:
- How to build a trading strategy
- How to backtest a strategy
- The definitive guide to swing trading
- The definitive guide to day trading
- The definitive guide to algorithmic trading
FAQ
Why is day trading challenging even in a bull market?
Day trading poses challenges due to factors like most returns happening overnight, transactional costs, psychological aspects, and market noise. These elements make day trading demanding, even in favorable market conditions.
How does a bear market impact day trading?
Bear markets increase market volatility and irrational decisions, offering exciting trading opportunities. While some strategies may fail, robust and vetted strategies can be highly profitable in bear markets due to increased volatility.
Why do bear markets occur in the stock market?
Bear markets can result from various factors, including the implosion of sectors, loan bubbles, changes in monetary policy, and shifts in yield curves. They happen when events or information make people perceive stock valuations as too high relative to future performance.
How can I ensure my day trading strategy lasts in a bear market?
Ensure your strategy has been tested and survived previous market crashes. Backtesting during different market conditions, including bearish phases, helps build confidence in the strategy’s ability to perform well in future bear markets.