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Three Common Mistakes in the Bear Market

The fundamental analyst believes that a bear market starts when prices of major stock market indices, such as the Dow Jones Industrial Average (DJIA) or Standard & Poor's 500 Index (S&P 500), fall sharply. A 10% drop is typically called a correction. Most investors can handle that. However, a downturn of 20% or more in multiple broad market indexes, over at least a two-month period, is considered a bear market. By that definition, we are already there as the market has fallen nearly 28% in the last 3 months!


As shown in the graph below, it is important to note that this decline is steep compared to the previous bear markets.

When stocks begin to fall, for many investors, it's hard to know when they will recover. But an educated or professional investor knows where the bottom is! If you are a novice trader or investor, you may make many mistakes during a bear market.


1. HOPE

Investors, by default, believe in hope: a hope that the market will eventually go up, a hope that nothing will disturb the US Economy, a hope that nothing will happen to the stock of a good company. However, hope is NOT a strategy! It's similar to 'praying' when you are taking care of a sick person - it may make you feel good but does not change the reality of loss.


Solution: Don't hope - learn a strategy to handle a down-trending market! Learn when to get out in time. Learn to cut short your losses rather than sitting on them for years. This is especially true if you are closer to your retirement.


2. Lack of understanding of timing:

In a bear market, if you wait too long and stocks rise again, you’ve missed an opportunity to buy and won’t profit from the rebound in prices. But if you are too quick to pull the trigger, you may see your new stock purchases continue to decline further. How can one predict the market recovery? Yes, its possible to predict market recovery if you have the knowledge and you know what to look for. You have to be right at the beginning of this recovery, to reap the best profits.


Solution: Learn to read price charts. Without chart analysis, you are throwing your money in the dark, only to incur further losses.

3. Not appreciating the power of selling:

Many investors do not know how to profit from a falling market. They typically follow a 'buy-and-hold' strategy, as if they have to be married the stock. This is an outcome of the flawed psychology of 'hope'. An educated investor, on the other hand, can make a profit even when the market it falling by selling short. Selling short is the opposite mirror image of buying. If you do not know how to sell, you are losing 50% of the opportunities to make a profit.

Solution: Learn to sell-short. This way, you can make profits even in a down trending market.



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