(Picture above: Bear catching game: You know, that annoying game that your kids make you fork up some change that always loses. That game that always ends in a body jerk "AAAAWWWW" and a "Dad please one more time." That game can be as frustrating as catching a real bear (market). Hopefully our steps below will be a better outcome, that said "bearer" beware.)
Because we've come to the realization that our work could be perceived as a tad fundamentally bearish we wanted to supplement an important step to the bearish investing process.
Being bearish and catching a bear are two different things. We want to be correct AND profitable. So let's start.
Step 1) Understand the risks
The game in the picture above is a net loser. Many people have lost a lot of money trying to guess a market, especially when that market is going in the opposite direction. In fact, trading in the wrong direction has led to many trading bankruptcies.
Step 2) Be a bear
You can't hope to have any staying power in a bear move unless you actually believe that the market is going to go down. If you don't truly believe that the market is going down it will lead to a "chop." A chop means that an investor buys when s/he sees it's up because s/he believes its going up. S/he sells when it goes down because, oh yeah, the bearish fundamentals. You have to pick a side with a lot of information and believe in it.
If you need help being a bear you can go to this SA contributor's research and you'll find plenty of fundamentally bearish reports (Elazar Advisors, LLC).
Step 3) Go to cash and start small
If you truly believe that there is a bear move coming the first step is start small. There has not been a meaningful bear move since... January (wait a minute that's not so long ago). Wow, that's crazy, it feels like the market can never go down but the market crashed in January. That should remind us that anything is still possible.
Getting to cash and being ok with the market going up without you is a test of will but is important to catch the bear. Being in the market when it goes up and selling when it goes down causes the "chop" we spoke about earlier. Pro traders can do it, if you are one. But regular people, we think, need to do things more gradually and prepare step by step.
Step 4) Only enter when you see it already working
Even though we're at number four chronologically, this is probably the most important step. Many people have been right but in the wrong timeframe and went out of business. We need to be right and in the right timeframe. We are fundamental analysts, we believe that fundamentals matter. That said, technicals and action (how the market responds to news) are extremely important. Latch on to a smart/profitable trader or see it happening yourself.
Signs to look for include: the market breaks recent multi-day lows, closes on it's lows, goes down on bigger volume than it goes up, consistently opens down. Those are signs of a bear.
This may be incredibly simplistic but it is amazingly important. If you can honestly say to yourself, "The market is going down" because you see it going down, that is a good sign. But if you can't honestly say that, it's not a good sign.
This market has been, "Honestly inching up." That's not yet a bear, but it can change fast and you'll be ready if you "buy the bear." If you can honestly say, "this market is going down" because you see it going down, it will be a good sign.
One of the most impressive things I've seen from the best traders is the simplicity of saying, "the market's going up" "the market's going down." If you can see it and honestly say it, it is a very powerful combination. Hope it's going down is not a profitable strategy, seeing can be.
Usually, also, the market on the downside needs a catalyst. That speaks to action. It needs something to point to where a PM needs to go against all of her/his work and say, "this is different." Ego aside, "we need to get out of stocks." Hearing that catalyst is good for bear. When bad news leads to down prices, and they stay down, that's a good bear sign. Generally a bull market is more gradual and doesn't have those news catalysts but a bear can.
And don't average as the market goes up. Rule number 1 in Gartman's (Famous) Rules of Trading is never add to a losing position. Usually, adding to a bad position, means your wrong and your adding to "wrong." Like any good business, invest in what's working. When the bear starts working, you'll be able to put more money to work.
Step 5) Lock In To A Trend
Our commenters pushed us by asking how to position for a bear market. We think that if we end up being right, the bear move could be a multi-year move. That means by 1) seeing it coming 2) seeing it happen 3) gradually positioning for it 4) seeing green on your screen (profits) and building confidence then the move can be a profit generator for several years.
Fed's Giving Us A Window
We think based on the Fed slowing addiction spending to the market, stocks have been a creep higher. Investors don't want to lose performance and so force themselves to stay long and follow the slow steady, yet extremely risky, trend higher. But they know that the trend is fundamentally wrong and it's going to hurt whenever it changes.
That said, markets don't care what investors want, the market has a mind of its own and goes much further for much longer than people usually expect. That fact wipes people out. That's why it's important to "see it happen" before you jump in. And entering really is not "jump in" but rather tip toe in.
Trade With Someone
The above is great in concept but implementation is very difficult, we admit. One great way to catch a bear is to do it with someone else in real life. That will help you manage and stay disciplined.
The best traders have an army around them, and you want to do it yourself? Meditate on that for a moment.
Smaller traders can have a trading friend. Make a rule that no trade is done without speaking together first. It saves you from a lot of discipline mistakes of doing things you didn't plan to do in the heat of the moment.
Trading smaller will also help with discipline and avoiding the chop. Trading smaller also works best with a trading friend.
Timing, Catalysts Will Prevail Over Fed
As for our best guess on timing, we think it depends on catalysts.
The Fed is not letting up on liquidity, yet (See Is The Fed Buying Stocks). Therefore we need the Fed to either begin selling their investments which will push stocks lower or we need a real market catalyst. Because the Fed has not yet been raising their cash by selling securities, the market is not going down on its own. But, because they are not raising cash, the market is awash in liquidity and is likely the reason it is inching higher.
That said, we think, catalysts will prevail.
What are catalysts? Between FOMC, Brexit, weak Dollar, China's sputtering oversupply, Europe weak, earnings, oil, war, there is enough out there to say that things can change.
And with a VIX (NYSEARCA:VXX) telling you the market is pricing in, and we say boldly, no risk, that catalyst will impact the market.
Catching a bear is as tough as that kiddy game in the picture. Just when you think it's in your grasp, the game's metal claw opens up in dismay without a bear prize.
Catching a bear takes a lot of discipline. Before you try to implement anything, read the above a few times. It is direction based on real life (painful) lessons that most traders have been through and some, in the end, get it. If you can implement the above with discipline you have the chance to catch a bear.
Disclosure, we are short S&P 500 (NYSEARCA:SPY) through ES.
Good luck and please be in touch. All of your comments teach US a ton and give us the best ideas for what to write next!!
Elazar Advisors, LLC specializes in earnings and predicts, analyzes and reacts to earnings and earnings events as well as developing current company and macro stories with a hedge fund perspective.
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Disclaimer: All investments have many risks and can lose principal in the short and long term. This article is for information purposes only. By reading this you agree, understand and accept that you take upon yourself all responsibility for all of your investment decisions and to do your own work and hold Chaim Siegel, Elazar Advisors, LLC, bestideas, their related parties, and its authors harmless.
Disclosure: I am/we are short ES BUT THAT CAN CHANGE AT ANY TIME AS MANY TRADERS KNOW.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.