What to Do in a Down (Bear) Market?

The stock market often falls under the conditions of the so called bull and bear markets.  Intelligent investors are well familiar with the conditions of both and know exactly what to do. 

Under a down market you have several options.

- One of them is to sell immediately in order to minimize your losses.

- Another option is to let the market work its way through the problem with no action from your side.

- A third option is to benefit from the stock decline and add some more to your portfolio. But, this should be done only if you don't perceive that there is something wrong with the company that has led to the stock decline.


Final Piece of Advice

Never forget that it is important to base your decisions on knowledge not on feelings. This means that being educated about the company and the industry from which your stocks come from, the market conditions under which you operate will be of small importance to you.

How to make money in a down market?

Here is an example of making money in a down market.

At the end of 2007, an investor was enthusiastic about a stock ABC.  Then the severe bear market of 2008/2009 intervened.  Here were the investor's transactions in stock ABC.

1.11.2007  Bought 1000 units  @  $6.00          Purchase value  $6,000
6.11.2007  Bought 1000 units  @ $ 6.75          Purchase value  $6,750
15.9.2009  Bought rights 800 units @ $ 2.80    Purchase value  $2,240
!5.9.2009   Bought 5,500 units  @ $ 3.51         Purchase value  19.305

Total bought 8,300 units
Purchase value  $34,295
Average price per unit $ 4.13

Current price per unit  $ 5.51
Current value of these 8,300 units is $ 45.733.

This is a total gain of $ 11,438 or total positive return of 33.4% on the invested capital, excluding dividends, received for the investing period..


Lessons:
1.  Investing is most profitable when it is business like.
2.  Stick to companies of the highest quality and management that you can trust..
3.  Stay within your circle of competence.
4.  Invest for the long term.
5.  Generally, hope to profit from the rise in the share price.
5.  At times, the share price becomes cheap for various reasons # - be brave to dollar cost average down, provided no permanent deterioration in the fundamentals of the company..


# Severe bear market of 2008/2009.

Peter Lynch talks about bottom-fishing on Wall Street

http://multibaggersindia.blogspot.com/2010/11/investing-strategies-from-peter-lynch.html

Why Now's the Time to Get Defensive

Why Now's the Time to Get Defensive
By Todd Wenning
January 13, 2010

Do you hear that?

 

To steal a phrase from Simon and Garfunkel, it's the sound of silence in the market. And it's making me nervous.

 

Remember just 12 months ago, when the CBOE Volatility Index, the "VIX," was comfortably over 40, implying significant investor uncertainty? Those were indeed scary times, a few months after Lehman Brothers collapsed in September 2008, but as an investor I was actually more comfortable then than I am right now. There were a lot of great stocks on sale!

 

You haven't heard about the "VIX" for a while now because, guess what, it's back below 20 -- implying investor complacency. We haven't been this low since (gulp!) August 2008, before the Lehman Brothers debacle.

 

Scared yet?
Even though the stock market has charted a steady upward course since last March, I have a hard time believing that all is well enough in the global economy to justify complacency.

 

That's why now is the time to get defensive. That means:

 

• Having cash available to invest.
• Considering options strategies to protect your gains.
• Building a watch list of stocks you'd want to buy at 10%-15% below current prices.

Traditional defensive maneuvers would typically include increasing your bond exposure, though with yields so low and interest rates inching higher, I don't think this is a great place to put new money right now.

 

My best friends call me "Cash"
Thanks to the government's policy of low interest rates and quantitative easing, there's been (by design) little reason to hold a lot of cash. That's helped fuel both the bond and stock markets, as investors looking for even a tiny profit needed to put their cash to work somewhere.

 

Still, cash isn't trash and there's simply no substitute for quickly seizing opportunities in the market. If you're 100% invested and the market loses value, you need to sell something (at a lower price, of course) before you can buy anything else. That's a tough position to be in when stock values become much more attractive.

 

In our Motley Fool Pro portfolio, for instance, we took advantage of last year's market downturn by using our cash to pick up solid companies like Intel (Nasdaq: INTC) and Autodesk (Nasdaq: ADSK) at very attractive prices. Today, we've strategically left a large cash balance in the portfolio to grab future bargains the market may throw our way.

 

Yes, you have options
Market volatility plays a major role in the pricing of options (calls and puts). This is because investors perceive "risk" as volatility and when volatility is low there's simply less demand from options buyers (who have the right to buy and sell a stock) who seek to improve returns with big moves in stock prices.

 

All of this is to say that when options prices are low and the market's been rallying, consider protective puts on stocks and exchange-traded funds that have made you big money.

 

Let's say you bought 100 shares of SPDR Gold Trust (GLD) ETF in November 2008 for $75 -- a $7,500 investment. The ETF currently trades for about $113 -- a nice 50% gain for you. By purchasing a March $110 put for $2.75, you can lock in a sales price of $110 for your 100 shares through March 19, 2010, for $275 per contract.

 

One scenario: The ETF doesn't fall below $110 by March 19 and you're out $275 (4% of your original investment). But hey, you can still enjoy any upside left in the ETF. The other scenario: The ETF falls well below $110, but you can still sell for $110 (minus the $2.75 per-share cost) thanks to the protective put you bought.

 

Think of buying protective puts on your big winners as insurance against the chance of losing those gains in a market downturn. Even though you may grumble when you pay the premium for the put, just as with your auto insurance, you'll be glad you did if something bad happens. At the very least, it can give you some peace of mind in an uncertain market.

 

Make a list, check it twice
U.S. stocks have made a huge recovery from their March 2009 lows, and while I don't think they're anywhere near bubble territory, good values have become harder to find. That doesn't mean you should stop researching, though.

 

Here are five S&P 500 stocks with returns on equity over 15%, price-to-free cash flow ratios below 20, and manageable debt levels -- in other words, strong companies worth buying if the market does take a downturn.

 

Company
Price-to-FCF
Return on Equity
Total Debt to Equity

 

Coach (NYSE: COH)
15.9
38.7%
1.37%

 

Gilead Sciences (Nasdaq: GILD)
16.0
49.4%
24.40%

 

Cisco Systems (Nasdaq: CSCO)
18.0
15.2%
25.70%

 

Stryker (NYSE: SYK)
18.3
17.7%
0.30%

 

Automatic Data Processing (NYSE: ADP)
17.1
25.4%
0.70%

 

 

Data provided by Capital IQ, as of Jan. 12, 2010.

 

 

Great companies don't always make great investments -- they still need to be bought at the right price.

 

Cisco Systems, for instance, has doubled its net income over the past decade, but remains 50% off its January 2000 prices. That's because investors were paying too dearly for Cisco's prospects during the dot-com bubble and, even though Cisco is a much better company today than it was in 2000, its 10-year stock chart doesn't reflect this progress.

 

That's why it's so critical to buy great companies only at the right prices. Another market dip could give us that opportunity, so prepare yourself now with a good watch list.

 

Get started now
When the market grows complacent, you need to get defensive -- no matter where you think it's going. It's only a matter of time before something spooks the herd and volatility once again ensues. By having adequate cash on hand to buy solid stocks at good prices and using options strategies to protect your gains, you can set yourself up for better long-term investment success.

 

That's our aim at Motley Fool Pro, where we use stocks, ETFs, and options to help investors make money in all types of markets. If you'd like to learn more about Pro, simply enter your email address in the box below.

 

http://www.fool.com/investing/general/2010/01/13/why-nows-the-time-to-get-defensive.aspx

Six Defensive Moves in a Down Market

Six Defensive Moves in a Down Market
A Great Time for Regular Investing

by CraneAmyButtell
24.12.2008



Market volatility is enough to give any investor heartburn these days. Although there have been some notable gains — the Dow Jones industrial average’s 889.4 point gain on Oct. 28 being one of the most impressive ever — most of the volatility has been on the downside.


With the media delivering one grim story after another about the economy, most observers aren’t expecting to see the market stabilize soon. Unemployment is up, banks aren’t lending, big corporations are teetering on the brink of bankruptcy and banks are failing at a rapid clip, news that doesn’t exactly inspire confidence.

Still, with so much riding on your investments, including your retirement and your kids’ college savings, you might feel it’s time to position yourself somewhat defensively given how long this downturn might last. You don’t want to stop investing, because there’s no way to know when the market will rebound; you have too much to lose by being out of the market at the wrong time. But here are some steps you can take to lessen the pain and position yourself as best you can.

Dollar-Cost-Average Your Contributions

You’re most likely already doing a lot of dollar-cost averaging — investing a set amount regularly — if you’re contributing to a 401(k) or college savings plan. This is a good strategy no matter what the market is doing because when you dollar-cost average, you buy more shares when prices are lower and fewer shares when prices are higher, keeping your overall cost basis down.

If you can employ this technique with your other investment accounts, do so. By dollar-cost averaging in a volatile market, you keep your cost basis down. If prices fall farther, you’ll benefit more by spreading your purchases out over a longer period than if you just invested a lump sum all at once.

For example, if you have an individual retirement account and plan to invest the maximum allowable of $5,000 annually, you could arrange to have $416.66 transferred from your bank account to your IRA every month and have that invested in the stock, mutual fund or bond of your choice. Or you could invest the money all at once in your IRA at the beginning of the year, then dollar-cost average it out yourself over a year.



Consider Stop-Losses?

Stop-losses aren’t a good idea for most investors in most long-term investing situations. But if you absolutely cannot afford to lose more than a certain amount of money in your investment accounts, this strategy is worth considering.

You might fall into this category if you’re a retiree on a fixed income with only a certain amount of assets in your retirement account besides your Social Security. To implement this strategy, you either call your broker or go into your online investment account and set a floor on some of your investments. When the prices of the securities you select reach those floors, your brokerage will automatically sell them.

Keep in mind, however, that in falling markets the price can blow right by your stop-loss order and you may be sold out at a much lower price. This is why you should employ this strategy cautiously. (Editor’s note: Many investors don’t like stop-loss orders because of their automated nature and because they might cause you to sell high-quality stocks that drop for reasons unrelated to their fundamentals.)

Save More

In a difficult economy, it makes sense to hunker down and cut your expenses where you can. Unemployment is rising, and you never know when you or your spouse might be out of a job. If you do hang on to your job, later on you can invest some of your excess cash for your retirement, your children’s college education or any other long-term goals you have.

Below are the extra savings you can expect to generate for differing saving rates. The following assumes you’ll reap 8 percent annual compound interest, pay 25 percent in federal taxes and 6.5 percent in state taxes, and see an average inflation rate of 3 percent:

• by saving $50 a month for 30 years, you increase your savings by $25,970
• by saving $100 a month for 30 years, you increase your savings by $51,940
• by saving $200 a month for 30 years, you increase your savings by $103,880

Stretch Out the Long Term

Change your attitude on what constitutes the long term and remember that stocks historically have averaged an annual return of 10 percent or more. Think of the long term as 20 or 30 years, or even more, rather than five or 10 years.

Because stocks increased so much in the 1990s and in the 2000s after the end of the dot-com bust, the law of averages dictates that the market will then have a number of average or subpar return years at some point.

Large returns are nice, but there’s no guarantee they’ll continue in the short run. History shows that the stock market has produced many years of ugly returns, even consecutively, or returns that have gone essentially nowhere over a number of years. Think about the late 1920s and 1930s as well as the mid-to-late 1970s and early 1980s.

Surviving a negative or sideways market that lasts for years takes a lot of patience. In those circumstances, continue dollar-cost averaging, work on bolstering your cash cushion and save every dime you can get your hands on.

If you’re getting close to retirement age, consider staying on the job a few years longer to shore up your nest egg. If that isn’t a possible, consult or take on a part-time job.

Just about the worst thing you can do is start drawing your assets down when the market is tanking, as it will be difficult for your investments to recover sufficiently to fund the rest of your retirement, given lengthening life spans.

Check Your Asset Allocation

With stocks and below-investment-grade bonds taking substantial hits in the last few months, it’s likely that your target asset allocation is out of whack. Take a look at your investment accounts and determine what you need to do to get back to your target allocations.

Financial planners generally recommend that you reallocate assets periodically, with once a year being a good benchmark. At this annual reallocation, you should move investment funds from asset classes that have done well, or at least have not done as badly as others, and move them into those that have declined, such as stocks.

Given the uncertainty of the markets, it might make sense to reallocate gradually rather than all at once. For example, if your investment accounts total $100,000 and your target allocation is 60 percent stock, 20 percent bonds and 10 percent cash, you could move funds out of bonds and cash gradually to bolster your stock allocation up to the preferred target.

Such a gradual shift could work in several ways. For example, you could move money out of bonds into cash all at once, then gradually dollar-cost average into stocks over the next six months or year or so. (Editor’s note: Be careful with asset allocation so that you’re not trying to time the market, an often disappointing venture. Many investors believe that for a long-term portfolio, there’s little reason to own anything except stocks.)

Expand Your Cash Cushion

Cash is an important bulwark in a falling market and during what’s shaping up to be a potentially long recession. When you have enough cash to last out the ups and downs of the markets without having to sell any of your investments, you can respond to market developments rather than react to them.

Financial planners recommend that employed workers have six months of living expenses squirreled away. Retirees should have at least two years of cash, preferably more, so that they can ride out a bear market of several years without having to sell investments at fire-sale prices for living expenses.

If you’re still working, see where you can trim your expenses and direct those savings into a bank savings or money market account. Interest rates on these savings vehicles aren’t great, but the ease of access to these funds is the most important factor.

With an expanded cash cushion, there’s less danger that you’ll need to tap your investment accounts for funds, whether by liquidating taxable mutual funds, stocks or bonds or by arranging to borrow from your 401(k) account.

No Time to Cash Out

When positioning your portfolio, it makes sense to play both defense and offense. Just remember not to give in to your emotions and get out of the market altogether, no matter how dire the markets and the economy may seem today. The next upturn is impossible to predict.


http://www.betterinvesting.org/Public/StartLearning/BI+Mag/Articles+Archives/0109mfmpublic.htm