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How to Swing Trade in a Bear Market (Not Only Short Selling)

Last Updated on 11 September, 2023 by Samuelsson

Swing trading comes with a lot of challenges, and while many people easily manage to stay profitable in an ongoing bull market, a lot of those people give away their hard-earned profits in the following bear market. So how do you swing trade in a bear market?

In order to swing trade profitably in a bear market, you could go about in several ways. Some people will choose to stay in cash until the bearish phase ends, others will be more strict with their entries and reduce their position size, and a third group will resort to short selling.

So how do you know what you should do when the bear market rears its ugly head?

Well, in this article we set out to sort this out. In addition, we’ll be sharing some valuable tips and general observations about a falling markets that we think are good to know!

Let’s start!

What is a Bear Market and Why Does It Occur?

The first thing we need to set clear is what a bear market is technically speaking.

How to Swing Trade in a Bear Market (Not Only Short Selling)

A bear market is when prices fall 20% or more from recent highs, signaling pessimism and a negative outlook by most market participants. Most bear markets occur in combination with declines in the bigger market indexes, like S&P-500, which tells us that the market overall is bearish. Still, downturns of the previously mentioned size in individual securities also qualify as bear markets, although the impact on market sentiment isn’t as widespread and unforgiving as during more widespread bear markets.

So, why do bear markets occur?

There is no one answer to this question, but on a more general level, falling markets are caused by events or developments that make enough people believe that the current evaluations of stocks and securities can’t be justified based on the anticipated future performance.

These events could include:

  • Shifts in yield curves
  • Monetary conditions and policy
  • The implosion of some parts of the economy
  • Loan bubbles going bust

Of course, these are just some examples of single events, and most of the time there are several factors at play.

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Does Swing Trading Still Work in Falling Markets?

Bear Market
Bear Market

Now we might want to know if swing trading really works well in bear markets. Here is the short, two-sentence answer:

Swing Trading does work in bear markets, but it will generally be a quite tough ride. You need to account for big market moves, which definitely could be in your favor, but generally require you to use bigger stop losses.

During the financial crisis of 2008 there where many swing traders who made exceptionally well on mean reversion strategies. Market players simply were exceptionally affected by common psychological factors like greed and fear, which produced a lot of swings that were incredibly profitable with the right strategies!

Of course, you’ll have to make sure to have a strategy that is likely to survive the changing market conditions. We’ll look closer at this in just a bit!

Important Things to Know About Swing Trading and Bear Markets

Before we go on to describing the four different ways of approaching a falling market, we’ll look at some important aspects of bear markets and swing trading that you should know about! As you might have guessed, the characteristics of a bear market differ quite a lot from those of a bull market, which will have some significant impacts on how we trade those market conditions.

With that said, let’s look at some of the most important things you should know!

Related reading: Can You Go Short When Swing Trading?

More Volatility

Bear markets generally are much more volatile than bull markets. While bull markets tend to go up in small increments for each time period that passes, bear markets tend to lose a lot of value at a rapid pace, and also provide much less even moves.

The reason is quite simple. During bull markets, investors and market participants remain calm. Their positions and investments appreciate slowly and steadily, only with occasional hiccups. As such, there isn’t so much to worry about, and the outlook looks fine. In fact, the longer a bull market has persisted, the more positive the sentiment tends to get. People are simply looking at the past and assuming that what has been will continue into the future.

On the other hand, during bear markets, people alternate between feelings of extreme fear and greed, which results in extreme shifts between big declines and quick recoveries. These high volatility conditions are perfect opportunities for traders who know their profession well, as the psychological turmoil surrounding the markets create a lof of profitable buying opportunities!

The increase in volatility means that you probably should decrease your position-size, since it’s very likely that you will have to use much wider stops not to have them hit in vain all the time. However, this varies a lot depending on the trading strategy you use. We’ll look at this in just a bit!

How to Swing Trade in a Bear Market (Not Only Short Selling)

Bear Markets Don’t Last That Long

Another thing to keep in mind about falling markets is that they don’t last as long as bull markets. While bear markets last 1 year and 9 months on average, bull markets tend to last between 4-5 years on average. Of course, individual bull markets will deviate from the average figure, but it still remains clear that bear markets are fairly short.

This will have some implications for the four approaches we’re going to discuss later on!

Read more about swing trading indicators.

Mean Reversion Strategies May Fail Abruptly

Mean reversion is a trading style where you try to pick local bottoms in the market, and exit once you’ve had a positive move up. Mean reversion traders assume that the market performs exaggerated moves in either direction and simply wait for the corrective move.

Mean Reversion
Mean Reversion

Mean reversion swing trading tends to work very well in the stock market, which has to do with the following factors:

  1. The market as a whole has an underlying bullish drive which helps to make declines shallow and short-lived.
  2. The psychology of market players, involving fear and greed is especially prevalent in the stock market, which causes a lot of overreactions which are then corrected. The correction is what we try to take advantage of as mean reversion traders.

Here comes what’s important to note!

Since mean reversion often uses a type of exit that gets you out of the trade when the corrective move has happened, you won’t get out of the trade if the stock goes against you. Of course, you may use a stop loss to exit the trade if the stock falls too much, but then you’re also exiting at a time when the edge is at its strongest.

Now, regardless of whether you’re using a stop loss or not, you’ll find that some weaker mean reversion systems will stop working quite abruptly. It may be that you give back half of the historical performance over the last 10 years in one single trade, just because the market tanked so rapidly as you held on to your position.

Of course, having a stop loss will mitigate this issue, as will making the decision to only trade trading strategies that have really strong historical performance. In the latter case, it’s common to see that the market will mean revert also in times of market turmoil! Again, we’ll look at how you determine what strategies stand a chance later in the article!

Three Ways to Approach A Bear Market

With all this covered, it’s time to go on to three different approaches you may take when facing a bear market. Which approach you should choose depends on how confident you feel about your trading strategy, as well as on personal preferences.

1.Short selling

Some people will resort to adding short selling to their swing trading arsenal in an attempt to profit from the steep declines that are so common in bear markets. Those who manage to get it right certainly can make a lot of money. However, it’s important to note two things:

  1. You might see new restrictions on short-selling when the market declines too much in a short period of time. This is imposed in an attempt to relieve selling pressure in order to stabilize the market.
  2. In bear markets, swings occur fast, both to the upside and downside. As we mentioned earlier, the market will alternate between the extremes of fear, greed, and euphoria, which will give rise to sudden and unexpected turns.

With these two aspects in mind, going short in stocks during these times could be a reasonable approach given that you know what you’re getting yourself into. However, the difficulties with regards to not only short-selling itself, but also restrictions imposed by the exchange, make this an approach that should not be taken by most people.

Another thing to remember is that gaps often take huge sizes in bear markets, which could mean that a short position that closes at a profit quickly turns into a massive loss as the market gaps up the next day!

Remember! When holding unleveraged long positions, the maximum amount you can lose is always 100%. However, with short positions, the amount you may lose is, at least in theory, unlimited.

2.Tighten Criteria for Taking trades

Another approach that is often taken by traders is to become more selective about the signals you act on. While you may feel inclined to take signals that are mediocre during a strong bull market, that should change as you enter a bear market. You simply don’t have the continuous positive drive to hold your back.

Depending on what strategies you use, “tightening your criteria” may mean different things. For mean reversion strategies where we buy dips, you might want to demand that the market becomes more oversold than usual before you take a signal. That way you increase the likelihood of an imminent reversal, which should mean that more of your trades actually become winners.

When it comes to other types of strategies, like breakout strategies, you may want to add some extra distance to the breakout level so that it isn’t triggered as the market makes some random, big swings. How this is done is something you can read more about in our guide to breakout trading.

3. Stay in Cash

The third option is to simply stop swing trading and stay out of the market. This might not seem like the most compelling option but could suit those who:

  1. Are very unsure that their strategies are going to be able to endure a bear market. Perhaps because their strategies have only been tested on bullish market conditions. (More on this later!)
  2. Can’t cope emotionally with going into a market that seems to be in free fall, amidst ominous media and news coverage.

Regardless of the underlying reason, there is nothing wrong with staying in cash when you’re not feeling prepared to tackle the markets. The important thing is that you make a final decision not to trade, and don’t become tempted to enter the market at random times. Just set a date for when you’ll consider getting back to your trading, and don’t think more about it! Just following this piece of advice will save you a lot of money

4. Trade Smaller Positions

If you’re unsure of whether you should continue to trade or not and don’t want to completely shut off your strategies, you could instead decide to trade with a smaller position size than you would normally. This has benefits like reducing your emotional stress levels and letting you play the market while reducing the risks of going bankrupt.

In general, reducing your position size is a great approach when you get into uncharted territory that might require some testing to inject trust in your methods.

How To Maximize Your Chances That a Swing Trading Strategy Will Work in a Bear Market

In swing trading, it’s paramount that you trust your strategies to such a degree that you feel confident in placing trades under the market conditions you’ve chosen to trade in.

One big issue with many swing trading strategies is that they’re tested and validated only during very bullish market conditions. While this might not become an issue as long as the market remains in a bull market, it definitely can, and probably will, when we enter a bear market.

So how can you increase the odds of your strategies surviving bear markets?

The answer is very simple. You have to extend your lookback period to include more varying, and primarily bearish market conditions. While we cannot assume that the next bear market is going to behave like the previous one, we at least can assume that the conditions of the previous bear market will be more similar to the coming bear market, than the preceding bull market.

Our guide to backtesting covers this topic in greater depth. Be sure to check it out if you want some more advice on how to properly test a trading strategy!

Extra Tips on How to Swing Trade Profitably in Bear Markets

Swing Trading Tips
Swing Trading Tips

Let’s now round off this article with two tips on how you can increase the odds of surviving your next bear market!

Make sure to manage your drawdown correctly!

Many traders don’t know their own risk tolerance prior to going live in the markets, but assume that everything will work out as they start trading. This is an assumption that could pose a real danger to your account balance, as well as emotional well-being.

As a swing trader, you should always have a plan for the maximum allowed drawdown you’re willing to take. This number, in turn, should reflect and impact your position sizing, or put in another way, how much you risk on each trade. Then, if your max drawdown is hit, you could either choose to quit trading for a while, or reassess the situation, adjust your position size, and continue to trade.

Even though you might not recognize the need for a trading plan at the moment, having one will prove invaluable in the heat of the moment. We’re seldom that rational when we’ve incurred heavy losses, which could make us take bad decisions. One example would be the tendency of some to increase their position size after losing a lot of money, in an attempt to make back their money. Such behavior tends to lead to heavy losses and can be avoided to a great extent by setting up a trading plan.

Use Market Sentiment Indicators

If you yet haven’t had a look at market sentiment indicators, you definitely should. In short, they’re indicators that look at broader measures of market activity such as the number or volume of advancing and declining stocks. And since these usually aren’t that related to the price of the single security you’re trading, there are a lot of ways they could be used to improve the performance of an existing trading strategy.

Our guide to market sentiment indicators looks closer at some indicators and how they can be used!

Ending Words

Bear markets occur regularly and could pose a serious threat to your swing trading returns if the right actions aren’t taken. Which actions that are right for you depend on your own preferences and in this article we mentioned the following four approaches:

  • Going short
  • Tightening the criteria for taking trades
  • Staying out of the market
  • Decreasing your position size

In order to learn swing trading in the right way, we really recommend that you have a look at our massive article on swing trading. If you’re interested in learning how we swing trade ourselves, we also offer a swing trading course that will give you strategies that are ready to trade, together with a proven methodology!

Here you can find our archive with all our swing trading articles.

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