HOW TO MANAGE YOUR TRADING STRATEGY IN A BEAR MARKET
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In this video we look at past bear markets, and how anyone involved in the stock market, be it a trader or investor, could have taken simple action to protect their wealth, and of course how we can do the same in the next bear market.
Ben Carson in particular has completed some extensive research into past market behaviour, he has made a career managing institutional portfolios, is an author of four books, and was named as one of the top financial advisors in 2017, needless to say Ben has some great knowledge to share.
First let’s look at Ben’s blog where he shares the data from historical bear markets since 1950. Remember, a bear markets technical definition is when the market is down 20% or more.
In this table we have the S&P 500 data showing the peak to trough dates, followed by the decline percentage during each period. We can also see the duration of decline and equally as important the number of days taken for the market to return to its previous high.
The average bear market decline over the past 70 years was 30.2%, with some of the largest falls reaching 50% or more. As we approach the end of May 2022 the S&P 500 has hit a decline low of 19.6%, not quite a technical bear market, but very close.
The two key areas we look to improve on in the video is the maximum drawdown and the duration of drawdown, the objective is to reduce the decline, but equally as important, reduce the time capital is tied up, which I refer to as the opportunity cost.
There are however important points made by Ben before we move on, all of which I completely agree on:
Bear markets are normal and should be expected.
They can be painful, especially for the uninformed.
The reasons are always different but accompanying emotions are always the same.
No one knows how long they will last, but they do come to an end eventually.
Once you accept these points, navigating through a bear market becomes far easier.
A bear market can be measured across other major indices too, for example the Naz dack is down 30% at the making of this video, putting it clearly into bear market territory.
Prior bear markets in the Nazdak can be seen here, like the S&P 500 we have seen significant bear markets since 1970, reaching a significant 77.9% drop during the notorious dot com bubble in the year 2000.
Overall, the average bear market decline has been 37.6% for the tech index.
An approach Ben demonstrates to potentially benefit from a decline, is to buy at the technical definition of a bear market, therefore buying the Nazdack index every time it drops 20%. Similar to an approach I take although I look for a 25% decline before averaging in for a long-term position.
Using the 1990 bear market as an example, the table shows us that if we bought the index at a decline of 20%, after one year your return would have been just over 40%, after three years you would have returned 102% all the way out to 10 years where you would have realized a profit of over 1000%.
Overall, the average return across all the bear markets using a simple strategy of buying at a 20% decline, proved to be ok, however the drawback of this simplistic approach can be seen when there is a major bear market, for example, the dot com crash would have seen you invested for more than ten years and still be in negative territory, this is serious opportunity cost, also emphasising the importance of diversifying across sectors. There is an alternative.
Similar to other strategies in our group, we use a combination of the 20-week moving average and the weekly mack dee.
The rules applied in the following sets of data are simply sell when price closes below the 20-week moving average, and only re-enter when price moves back above the 20-week moving average, but only if the weekly mack dee line is also above the signal line.
Let’s see how this simple approach changes the performance during a bear market for both the S&P 500 and the Nazdack index.
First, we look at the decline percentages and the duration of capital employed for the S&P, in comparison to a buy and hold approach.
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Ok, first let’s look at the S&P buy and hold approach. Here we have the table we originally looked at showing the bear markets since 1950.
Initially we want to look at the maximum decline and duration for the S&P and compare it against the 20-week moving average mack dee approach. To get a good sample size and without the exercise becoming too exhaustive, we look back 35 years covering the last 8 bear markets.
If we re-adjust the averages, we get a 31.5% average decline and an average decline duration of 245 days if you took a buy and hold approach through each bear market.
Let’s now add the results from our alternative approach.
Applying our approach gave an average decline of 10.9% during a bear market decline and an average decline duration prior to selling the position of 35 days. Within some of these bear markets we would have re-entered and exited the index multiple times as per the strategy, with the dot com period taking a total of five trades.
Clearly the drawdowns were improved considerably, but the biggest difference was the duration of having your capital tied up during each decline, in fact this duration was reduced by a factor of 7 which is huge in terms of opportunity cost. Buy and hold would have seen you invested for almost a year on average, whereas our approach would have seen our capital committed for just over a month on average.
Let’s take a look at the current status of the S&P. We can see the price reached a high of 4820, we can also see that price closed below the 20-week moving average two weeks later, we would have therefore exited the position at a decline of 9%.
Notice how a few weeks later here, price closed above the 20-week moving average, however the blue mack dee line was still below the signal line, meaning that it was not the right time to re-enter.
The price of the index is currently down 19.6%, so already you would have saved just over a 10% decline and 18 weeks of your capital being tied up.
Next up we have the naz dack.
This is the original data showing the buy and hold approach of the naz dack index. Similar to the last example lets reorganise the table for us to compare the alternative approach.
We can see the buy and hold data here, and again we trim the data, this time going back five bear markets starting in 1998 and capturing the dot com bubble. The average decline for these 5 bear markets was 43.3%, and the average duration of decline was 333 days.
Again, by applying our approach of selling at the cross of the 20-week moving average, and only buying back in if price crosses back above AND the mack dee is above the signal line, we get these results.
The averages are improved considerably, the average decline duration equated to 67 days instead of 333 and the average decline was 22.1%, almost half that of the buy and hold approach.
If we look at the dot com bubble, our approach saved 26 percentages points although the drop was still significant at 51.6%, however we only had our capital tied up for 4 months, whereas the buy and hold approach would have seen our capital tied up for two and a half years, a factor of 7.5.
Most people focus on the decline percentage alone, but the duration of decline and consequential opportunity cost is just as important.
Let’s look at the naz dack currently.
We can see that price reached a high before closing below the 20-week moving average, at which point our approach would have seen us exit after a decline of 6.9%, thereafter price attempted to get back above the moving average but failed, whilst the blue mack dee has also remained below. As of today, the index is down almost 30%, therefore the approach saved us a further 23% drawdown, whilst not forgetting that our capital would have been locked up for an additional 22 weeks.
So, what can we take from this video?
Despite a history of economic upheaval, the markets always find a way to recover, however during times of upheaval, there are ways to mitigate risk and there are ways to avoid opportunity cost, this video showing the moving average mack dee approach is just one example.
Personally, when it comes to investing into an index I like to buy when the index has dropped 25% or more and often add more to the position at each additional 10% drop. Remember however, this averaging in approach is not for singular stocks, stocks can get lower and lower and never return, a well-diversified major index will (more often than not) return.
For someone who falls into the singular stock buy and hold trap, whilst averaging into to losing trades, check this video out.
And for those who want to see my singular stock strategy applying many of the principles in this video, why not join our group.
Thanks for watching.
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