How To Identify Common Bear Market Traps And Avoid Them?

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Investing in today’s volatile bear market can be difficult. 2022 was a difficult year for traders, with many of them falling victim to many traps waiting for unexpected investors. A bear market requires experience and know-how to navigate without losses – let’s try to shine some light on some of the most common bear market traps and discuss strategies that will help you avoid them.

What Is A Bear Market?

Whenever there is a general falling trend in overall prices on a given market, investors call it a “bear market”. When a market becomes bearish, traders can expect a long period of negative returns, leading to a general pessimism among investors. The term can be applied to any marketable security, but is most often used when describing the stock market.

For most investors, a bear market begins whenever there is a 20% or more decline in a major stock index, like the S&P 500 or the Dow Jones Industrial Average, lasting more than two months. The name “bear market” is supposed to be a metaphor for how bears attack their prey by swiping their paws down, which the downward movement of the market is mimicking.

However, even during bear market conditions, some companies manage to thrive. Following most recent macroeconomic challenges, companies in the technology and software industry witnessed encouraging growth, often outpacing both the S&P 500 and the tech-heavy Nasdaq Composite.

While some industries may experience more challenging stock market performance, these companies, often technology and software, experience positive growth, as they provide novice and seasoned investors with better returns and safer long-term investment growth.

In light of the most recent bear market conditions, some big tech companies, including Apple, Amazon, Google parent company Alphabet, Meta, and Nvidia, among others, boasted remarkable business and stock market performance, as they are considered safer investments, due to their industry dominance, and their ability to constantly innovate.

Common Bear Market Traps To Avoid

There are many causes of bear market periods – slowing economy, high unemployment, low disposable income, and more. However, bear markets are considered a natural part of the economic cycle and can’t be avoided – without bear markets, there would be no bull markets.

Once market conditions begin to improve again, investors often look for investment opportunities that can rise from the ashes of the bear market. One such example is the multinational chip and semiconductor manufacturer, Nvidia, which has seen its stock soar in recent months due to the ongoing demand for its products and services as Artificial Intelligence (AI) becomes more commercially available.

Consumer demand can often drive the direction in which stocks will grow. Tech is yet another good example of this. As more consumers transition their communication and work online, many will require different services and software. From basic tools such as virtual video conferencing, photography editing applications, or basic office communication software – these small trends can make a big impact on the way companies perform on the stock market and within their industry.

This might seem offbeat, yet, the recent tech and artificial intelligence stock bubble have seen a rush of new investors coming and going. Innovators across the world are beginning to understand the fundamental transformative influence of AI technology. The cause and effect essentially drives more interest in services and products, soon flooding the stock market and marking the beginning of the AI Gold Rush.

It’s good to keep in mind that some tech companies, such as Alphabet, Meta, Nvidia, and Microsoft are simultaneously developing generative AI tools that will help to further explore the transformative influence of AI technology. The global chipmaker, Nvidia, have witnessed company stocks soar by 160% this year, as their high-end chips now power several data centres and are used in products such as ChatGPT.  The company is now poised to become the first chipmaker to be valued at more than $1 trillion.

Some firms have partnered with smaller tech startups, such as the case with the creators of TikTok, Bytedance; while the company definitely has the ability to develop their video sharing and digital AI video editing tools themselves, they often rely on smaller stakeholders that have the expertise.

Investors have turned increasingly optimistic in tech, again. Earlier in the year, Palantir, a multinational data analytics company launched Gotham, an AI-powered government platform that allows users to better understand data patterns which enables them to locate and respond to potential terrorist threats. Palantir stocks have climbed by 141% year-to-date.

While challenging for investors, bear markets can present unique opportunities to buy quality stocks at lower prices. The key to navigating a bear market is to know how to avoid common investor traps and employ an effective strategy. If you’re a trader, you definitely do NOT want to make these mistakes:

Panic Selling

One of the most common traps waiting for investors during a bear market is panic selling. As prices take a plunge, many traders allow fear to cloud their judgement and make impulsive decisions. Don’t join the sheeps. Remember that investing is a long-term process, and temporary market downturns are normal. Every bear market has eventually given way to a bull market, and selling in panic could lock in losses and miss the potential upturn. Freeze assets that could still profit you after some time, and invest in valuable stocks that continue growing despite bearish market trends.

Researchers that have been following the process of panic selling, call it a “follow-the-leader process.” When one pocket of institutional investors are doing something, the other will follow.

All-in-all, panic selling is a stock market event that not only sees investors dropping their stocks on the get-go, but is rather a combination of several different market factors and influences. As the market bubble begins to expand, and droves of institutional investors begin to enter the market, stock prices begin to dwindle, and the AI Gold Rush begins to lose steam.

Luckily, this isn’t something that happens within one day, or several hours – it could – but this usually takes place over a specific period of time, and often many investors and financial experts predict that this will happen long in advance. This gives investors enough time to develop an exit strategy and ensure they make the right judgement that won’t cost them their position in the stock market.

Catching Falling Knives

Instead of panic selling, some investors become overeager to buy low-priced stocks during a bear market, hoping to sell them later for a profit. Unfortunately, inexperienced traders often end up buying into companies with declining revenues and little prospects, trying to catch the proverbial falling knife.

Don’t buy cheap stocks indiscriminately. Focus on companies with solid business models, stable finances, and competitive advantages – even if their stock prices are currently dropping, they are much more likely to make a comeback when the market becomes bullish again.

Ignoring Diversification

Don’t get fixated on specific stocks, or even specific sectors, believing they will recover the quickest when the market rebounds. While there is a chance these predictions may become true, such a strategy increases your portfolio’s volatility and loss risk. Diversify across various sectors and assets to manage risk and keep your portfolio stable in a bear market. You never want to put all of your eggs into one basket.

Neglecting Quality For Bargains

Lower stock prices may seem like bargains to inexperienced traders, waiting to be scooped up. Don’t get too eager – not all cheap stocks are good investments. As an investor, you need to be able to discern between genuinely undervalued stocks, and those that are cheap for a reason. Look at the company’s balance sheets, revenue streams, popular opinion, and growth potential before investing, even if the stocks are really cheap.

Overlooking Cash Reserves

Don’t get too swept up in the fever of investing, or you might end up with no liquid assets to spend. They can give you a much-needed safety net in times of bear markets and give you additional flexibility when new investment opportunities appear. Always keep a cash reserve as part of your portfolio strategy to keep yourself unrestricted.

Falling Prey To Scams

Watch out – financial scams are becoming more popular and harder to spot each year, and they’re especially common during bear markets. Scammers make money on investors’ fears and desperation to recover from losses.

Be careful of any investment that seems too good to be true, offering high returns with little to no risk. Before you make the decision to invest in something, always perform extensive research.