How to Trade a
Bear-Market Rally
By Jeff Clark
January 29, 2008
You cannot ride a bear.
Rodeo cowboys score points by staying on the bull as long as possible. Investors profit by doing the same.
But a bear is a completely different animal. No cowboy is crazy enough to saddle up and try to ride a grizzly. Yet investors try it all the time – and they get killed.
Bear markets are not for riding. They're for trading. That means you wait for severely oversold conditions before you buy anything. Then you sell when conditions become less oversold.
And you wait for severely overbought conditions before selling stocks short. Then you cover those trades when the market turns neutral.
It's not a buy-and-hold environment anymore. It's a scalping environment – play only the best setups and take profits quickly.
Last week was a terrific practice session for trading a bear market. Stocks started the week in oversold territory and drifted even further into the abyss during Wednesday's selloff. But if you paid close attention, you would have noticed that homebuilders and financial stocks held up well.
That was the first clue that we were getting close to a bear-market rally. You see, in bear markets, the stocks that have taken the biggest pounding turn higher first. Those same stocks also post the biggest gains.
Sure enough, stocks turned higher on Wednesday... and by Friday morning, homebuilders were up an average of 15% on the week, and financial stocks were up 11%. It was time to sell.
No, the stocks weren't expensive, and no, they weren't overbought. But bear markets are fickle creatures. Countertrend rallies can reverse quickly, and profits can disappear just as fast.
It's smart to sell stocks as they're moving up and buyers are trying to get in. You may leave some profits on the table. But that's better than holding out for the highest possible price and then having to exit the trade after the stock has turned lower and the buyers have disappeared.
If we're entering a bear market, then we're going to see a lot more weeks like the last one. So we'll have plenty of opportunities to profit. Just remember – we don't ride the bear. We scalp it instead.
Best regards and good trading,
Jeff Clark
