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Saturday, June 12, 2010

Investing in Bull & Bear Markets

Are we in a bull market or a bear market and should you care?

The financial and popular media is fascinated with labeling markets as bulls or bears as if that somehow describes what is happening to your stocks.

It is true that market risk – the danger that a declining overall market may affect your stock – is real. However, investors who have done their homework know the difference between a general market decline and something wrong with their stock.

Some High and Some Low

Look at any bear market and even at its lowest point you will find stocks that do quite well. Similarly, in any bull market there are stocks that do poorly.

A rising or ebbing tide does not necessarily raise or lower all the stocks in a market.

When the overall market is declining or rising significantly, the intelligent investor has a real advantage over the person who has invested on a whim.

If you know the company behind the stock, you will be able to judge whether the stock’s price decline is simply a reflection of the market’s general pessimism or a signal that something is fundamentally wrong with the company.


Armed with this knowledge, you can then decide whether to:

  • Sit tight and let the market work through its problems
  • Take advantage of the price decline and add to your holdings if you believe nothing has fundamentally changed with the company
  • Sell before the loss becomes worse
Whatever your decision, you are armed with information to make an intelligent decision.
In a bull market, your stock may take off with the market, which is not necessarily a bad thing. However, you may be concerned that the stock will become highly overpriced and will suffer a significant drop when the bull market ends.
Here are some options:
  • You could sit tight and let the market work thorough it problems
  • You could sell some of the shares (see example below) and buy back the stock when the price falls back to reasonable levels
  • You could sell all of the shares for a profit
You can protect yourself from the danger that the bull market had overpriced the stock so badly that it might fall below its true value in a correction several ways.
Here is one strategy. Say you own 500 shares that you bought at Rs. 25 per share. The bull market, and nothing else, has pushed the price up to Rs. 40 per share.
You want to hold the stock, but are concerned that a market correction might drop the price below Rs. 25 per share.
You sell 250 shares at Rs. 40 for a gross of Rs. 10,000. Assuming you have held the stock less than one year, capital gains tax takes 15%, leaving you Rs. 8,500, which you stick in a money market fund.
When the market correction comes, you buy back shares at a lower price. For example, say the stock fell to Rs. 20 per share. Your Rs. 8,500 profit will buy you 425 shares.
You now own 675 shares of the stock and have reduced your average cost from Rs. 25 per share to less than Rs. 22 per share and you didn’t take a penny out of your pocket.
250 shares @ Rs. 25/share = Rs. 6,250

425 shares @ Rs. 20/share = Rs. 8,500

675 shares @ Rs. 21.85/share = Rs. 14,750
Whatever course of action or inaction you choose, the intelligent investor always works from a position of knowledge. If you know the company and its industry, you will not worry about whether it’s bull or bear market.