We will now see how with our index trading system we can avoid to get trapped in bear markets. Instead we will learn how to profit from it. The first very important thing to do to avoid getting caught in a strong downtrending market is to folllow our stop loss system. We never know when we are stopped out if it is only for a small loss or for a long lasted major market fall.
We have three types of such markets. We have a one leg and a two legs bear market coming off normal market conditions. We also have a bear market coming off a recognized down trend. Over the years we had all three situations to deal with and our index trading system handles all of them very well.
Just before let's just define how we determine we just got involved in the beginning of a bear market. With our index trading system we calculate the band offset (See the
special oversold investment opportunities
for definition of band offset). If we have a band offset of at least 1.23 under the lower band, a bear market just started. We can in most cases observe that the trend we were in before is broken. 1.23 offset is a quite high oversold condition and it always triggers a rally. It is difficult to predict how big this rally can be. So to resume this paragraph here, when we get this 1.23 band offset and just before we were in normal market conditions we just entered negative market condition. If we were in a recognized down trend we wait for a 2% band offset to enter the market.
From now on we must be very carefull. In our index trading system we have a few mechanisms to measure how the market react after the initial recognition of the beginning of a downtrending market. First we measure over the next few days if the recovery that always follows is strong enough after about 10 days. If it is not we will immedialtely generate a sell signal. This then means we will have a second leg in this bear market. This second leg is much more violent when it occurs and this time we will look for a 2% band offset to reenter the market. If however the recovery was strong enough we will let the rally run until we reach a certain profit target and we will then generate a sell signal. We may not always reach that profit target. In any case the next move will be to search for a double bottom which always present itself if the band offset was not under 2.5% when we triggered the beginning of the negative market condition.
Lest's examine each one of them since 1990.
On august 6th 1990 we had a band offset of 1.70 triggering the beginning of a bear market. This was a 2 legs bear market. Our last signal was a regular buy signal. We not only have a possible stop loss condition but also a bear market. The bear market condition always prevail over a regular stop condition when they occur at the same time. The rally following was slim and a sell signal was generated. Then we were looking for a 2% band offset which occured on august 24th. The recovery was much stronger and we were exited a few days later with a profit. From now on we are looking for a double bottom which occured on september 24th. A few weeks later the market recovered for more than 2 months leading us to a 10% extra profit.
SP500 1990 market fall graphic
We had similar major market falls on the fall of 1998, spring 2001.
On april 4th 1994 we had a band offset higher than 2. This was a market condition coming off a recognized down trend. The band offset was higher than 2.5 so we let the market run from there which recovered significantly to enter a regular cycle until june 1994.
SP500 1994 market fall graphic.
We had simular fast falling markets on september 2001 and july 2002.
On october 27th 1997 we had a band offset of 1.7 coming off regular market conditions. This was a one leg bear market The market rallied enough immediately from that point to trigger a profit. We then waited immediately for a double bottom which occured in mid december 1997. Some months later we had a very strong market advance that leaded us to spring of 1998.
SP500 1997 market fall graphic.
We had simular strong downtrending markets on August 1999, october 2000.
As we have seen here handling bear markets is of the most importance not only to avoid big losses but get ready to high profits always coming after the bear market is completed. We observed an average of 8-9 weeks for a fast falling market to come to an end. But the one that occured in 2002 lasted 13 weeks if we count the downtrend started in early april.
We can also notice that falling markets always occur in the spring or late in the summer - beginning of fall. The only exception since 1989 was july 2002.
See how to profit from bear markets identifying special oversold conditions
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