How to Make Money in a Bear Market

A bear market exists when equity prices are down 20 percent or more from their highs. Bear markets often result in investors losing a lot of money, but a few simple techniques can enable you to not only survive the storm, but make a lot of money.

How to Make Money in a Bear Market

Recognize that you're in a bear market. The market will be down at least 20 percent from its highs. Technical chart patterns will have distinctively bearish formations, marked by lower highs and lower lows. Prices that had previously supported market declines will be broken through and new lows established on a daily or weekly basis.

Sell stocks short. Shorting a stock involves borrowing shares from your brokerage firm and selling them to a third party in anticipation of a price decline. Once the price has declined as far as you think it will, buy back the shares you sold short and close the position. You should only short companies you think will decline the furthest in a bear market. For instance, if you think the stocks of technology companies with no earnings have become too overpriced in a bull market, they would make excellent candidates to short in a bear market.

Buy put options. Puts appreciate in value when a stock goes down, and depreciate when it goes up. You can also buy put options on major indexes like the NASDAQ or S&P. This way you'll be betting on the broader market instead of just one stock.

Purchase bear market funds like those offered by Rydex. These mutual funds use derivatives to create short positions on the S&P or NASDAQ. If the market goes down, the funds go up. Some funds use additional leverage to produce two times the inverse return of the index. For example, if the index goes down by one percent, the bear fund will go up by two percent.

Recognize when the bear market is coming to an end. The market won't go to zero. Once stocks have declined by a large amount, investors eventually consider them undervalued and start buying again. Oftentimes the bear market is closest to the end when the majority of investors and the general public are most pessimistic, convinced there are sure to be lower prices and rougher times ahead.