Weathering the Storms of the Stock Markets (Part 4)
One of the safest but most extreme strategies is for an investor to sell all of his or her investments and either hold cash (sometimes in FX) or invest the proceeds into much more stable financial instruments, such as short-term government bonds. By doing this, an investor would eliminate his or her exposure to the stock market and minimize the effects of a bear market. Selling everything, also known as capitulation, can however cause an investor to miss any future market rebound.
For investors still looking to maintain positions in the stock market during a bearish run, a defensive strategy is usually taken. This type of strategy involves investing in larger companies with strong balance sheets and a long operational history, which are considered to be defensive stocks. The reason for this is that these larger and more stable companies tend to be less affected by an overall downturn in the economy or stock market, making their share prices less susceptible to a larger fall.
With strong financial positions, including a large cash position to meet ongoing operational expenses, these companies are more likely to survive downturns. On the other hand, it is the riskier companies, such as small growth companies, that are typically avoided because they are less likely to have the financial security that is required to survive downturns.
Bear markets can last months or years, and there are times where no clear signals exist as to when market recovery will commence. Additionally, there's no cap on how high a stock can climb and no guarantee that any stock will fall. Investors must be cognizant of the fact that most investments carry some inherent risk as such any strategy selected should be in line with the investment goals and risk appetite of the investor.