A falling market is not really what an investor wants to see, because it comes with a lot of tension and maybe losses. However, what if you could make money irrespective of the stock market direction or phase?

Whether it falls or rises or stays in a range, there is a way to make money if you know the right way. When you buy stocks, the only thing you can do for making a profit is to wait for the prices to go up.

What happens during a time when the economy is going through a rough patch and hence the markets are underperforming. Consolidations in stock markets are painful and they drive out many participants.

• Why are Investors Afraid of a Falling Market?
• How Should you Invest During a Falling Market?
• How do Investors Profit From a Falling Market?
• Where Does the Money go When the Stock Market Crashes?
• What to Invest in When Market is Falling?
• Why do Investors Lose in the Stock Market Crash?

Why are Investors Afraid of a Falling Market?

When you’re shopping for groceries and other goods, lower prices are generally viewed as a good thing. But with stocks, a plunge in prices sparks the desire to sell instead of buy. 

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Why is that? Because when you’re buying milk or bread from the grocery store, choosing a lower-cost item saves you money. In contrast, a falling stock market essentially costs you money in the form of an investment loss, and that’s scary, especially when retirement or other important investment goals are at stake. 

Until you sell, however, those losses are what are called “paper losses,” which means they’re unrealized and impermanent—a stock market recovery can cancel losses and return your portfolio to its original position, or even to a better one. If you decide to sell your stocks while the stock market is falling, though, the losses aren’t just on paper—they’re now a reality. 

How Should you Invest During a Falling Market?

If your financial situation gives you some room to take advantage of falling stock prices, here are some ways you can potentially turn that drop into a long-term profit. 

1. Focus on Diversification

One of the best ways to reduce your exposure to risk when the stock market is falling is to diversify your portfolio—this means investing in different types of stocks and other assets, such as bonds, mutual funds, real estate investment trusts (REITs), and more.

Each of these asset classes provides different levels of risk and potential returns, so including assets across the risk/reward ratio spectrum in your portfolio can help mitigate some of the heavier losses you may experience with some holdings.

2. Think About Your Time Horizon

Time horizon in investing refers to how long you expect to hold onto your investment. If it’s a retirement account, for instance, your time horizon is the year you plan to leave the workforce—which could be in 20 years for some people.

If you’re investing money for other purposes, your time horizon is the date you expect to sell your investments to realize your goal.

3. Avoid Trying to Time the Market

Guessing what’s going to happen with a particular stock or the stock market as a whole isn’t a good investment strategy. While there are certain fundamentals that can tell you whether a stock is a good investment, the stock market can still be incredibly volatile and unpredictable. 

Instead of trying to time your investment to maximize your profit, consider using an investment strategy called dollar-cost averaging. With this approach, you invest the same amount of money every month into the same investments. 

Dollar-cost averaging helps you remove the emotional component of investing from the equation. It also gives you the chance to “buy the dips” without trying to time the market and can reduce some of the uncertainty of whether you’re getting a good price.

4. Look at the Fundamentals

It’s important to understand both the strengths and weaknesses of each stock you own. With some research, you can find out how a certain stock performed in past market downturns and what its chances are of recovering from the current one. 

Take some time to research your investments to understand the fundamentals of their underlying businesses and how an economic crisis will affect them. During a pandemic, for instance, travel industry companies may suffer significant losses due to government-ordered travel restrictions, and recovery could be slow.

Online retailers, on the other hand, may have a good chance of weathering the storm relatively well, or even thriving, since they can still operate and ship items to people right in their homes.  

In other words, understanding the fundamentals of the companies you’re investing in can help you determine whether a price plunge is a sign of long-term struggles or just a short-term blip.

5. Consider Working With a Professional

If you’re a novice investor, a financial advisor can help you learn more about the process and give you some personalized advice on how to approach your portfolio. They may be able to help you diversify your portfolio, switch your investing strategy from aggressive to conservative, and more.

Whether the stock market is falling due to a larger economic crisis or simple everyday volatility, take a step back to think about how you can take advantage of the situation. Create a strategy to diversify your portfolio, research your investments, and avoid trying to time the market. 

Also, understand how much risk you can take on based on when you’ll need the money you’re investing, and consider working with a professional to help you ensure your approach is effective and, hopefully, profitable. 

How do Investors Profit From a Falling Market?

Find good stocks to buy

In a falling market, the stocks of both good and bad companies tend to go down. But bad stocks tend to stay down, while good stocks recover and get back on the growth track.

Hunt for dividends

A dividend comes from a company’s net income, while the stock’s price is dictated by buying and selling in the stock market. If the stock’s price goes down because of selling yet the company is strong, still earning a profit, and still paying a dividend, it becomes a good buying opportunity for those seeking dividend income.

Unearth gems with bond ratings

A falling market usually occurs in tough economic times, and it reveals who has too much debt to deal with and who is doing a good job of managing their debt. This is where the bond rating becomes valuable.

The bond rating is a widely viewed snapshot of a company’s creditworthiness. The rating is assigned by an independent bond rating agency (such as Moody’s or Standard & Poor’s).

A rating of AAA is the highest rating available and signifies that the agency believes that the company has achieved the highest level of creditworthiness and is therefore the least risky to invest in (in terms of buying its bonds).

The ratings of AAA, AA, and A are considered “investment-grade,” whereas ratings that are lower (such as in the Bs and Cs or worse) indicate poor creditworthiness.

Rotate your sectors

Using exchange-traded funds (ETFs) with your stocks can be a good way to add diversification and use a sector rotation approach. Different sectors perform well during different times of the ebb and flow of the economic or business cycle.

When the economy is roaring along and growing, companies that offer big-ticket items such as autos, machinery, high technology, home improvement, and similar large purchases tend to do very well, and so do their stocks (these are referred to as cyclical stocks).

Sectors that represent cyclical stocks include manufacturing and consumer discretionary. Basically, stocks of companies that sell big-ticket items or “wants” do well when the economy is growing and doing well.

However, when the economy looks like it’s sputtering and entering a recession, then it pays to switch to defensive stocks tied to human need, such as food and beverage (in the consumer staples sector), utilities, and the like.

Go short on bad stocks

A falling market may be tough for good stocks, but they’re brutal to bad stocks. When bad stocks go down, they can keep falling and give you an opportunity to profit when they decline further.

When a bad stock goes down, the stock often goes into a more severe decline as more and more investors look into it and discover the company’s shaky finances. Many folks would short the stock and profit when it continues plunging.

Carefully use margin

Many investors don’t use margin, but if you use it wisely, it’s a powerful tool. Using it to acquire dividend-paying stocks after they’ve corrected can be a great tactic. Margin is using borrowed funds from your broker to buy securities (also referred to as a margin loan).

Keep in mind that when you employ margin, you do add an element of speculation to the mix. Buying 100 shares of a dividend-paying stock with 100 percent of your own money is a great way to invest, but buying the same stock with margin adds risk to the situation.

Buy a call option

A call option is a bet that a particular asset (such as a stock or an ETF) will rise in value in the short term. Buying call options is about speculating, not investing. Remember, a call option is a derivative, and it has a finite shelf life; it can expire worthless if you’re not careful.

The good part of a call option is that it can be inexpensive to buy and tends to be a very cheap vehicle at the bottom (bear market) of the stock market. This is where your contrarian side can kick in.

If the stock price has been hammered but the company is in good shape (solid sales, profits, and so on), betting on a rebound for the company’s stock can be profitable.

Write a covered call option

Writing a covered call means that you’re selling a call option against a stock you own; in other words, you accept an obligation to sell your stock to the buyer (or holder) of the call that you wrote at a specified price if the stock rises and meets or exceeds the strike price.

In exchange, you receive income (referred to as the option premium). If the stock doesn’t rise to the option’s specified price during the life of the option (an option has a diminishing shelf life and an expiration date), then you’re able to keep both your stock and the income from doing (writing) the call option.

Writing covered call options is a relatively safe way to boost the yield on your stock position by up to 5 percent, 7 percent, and even more than 10 percent depending on market conditions.

Keep in mind, though, that the downside of writing a covered call is that you may be obligated to sell your stock at the option’s specified price (referred to as the strike price), and you forgo the opportunity to make gains above that specified price. But done right, a covered call option can be a virtually risk-free strategy.

Write a put option to generate income

Writing a put option obligates you (the put writer) to buy 100 shares of a stock (or ETF) at a specific price during the period of time the option is active. If a stock you’d like to buy just fell and you’re interested in buying it, consider instead writing a put option on that same stock.

The put option provides you income (called the premium) while it obligates you to buy the underlying stock at the option’s agreed-upon price (called the strike price). But because you want to buy the stock anyway at the option’s strike price, it’s fine, and you get paid to do it too (the premium).

Writing put options is a great way to generate income at the bottom of a bear market. The only “risk” is that you may have to buy a stock you like. Cool!

Be patient

If you’re going to retire ten years from now (or more), a bear market shouldn’t make you sweat. Good stocks come out of bear markets, and they’re usually ready for the subsequent bull market. So don’t be so quick to get out of a stock.

Just keep monitoring the company for its vital statistics (growing sales and profits and so on), and if the company looks fine, then hang on. Keep collecting your dividend and hold the stock as it zigzags into the long-term horizon.

Where Does the Money go When the Stock Market Crashes?

Well, the answer’s not so simple as “someone pocketed it.”

Money that enters the stock market through investment in a company’s shares stays in the stock market, though that share’s value does fluctuate based on a number of factors. The money invested initially in a share combined with the current market value of that share determines the net worth of shareholders and the company itself.

It may be easier to understand this given a specific example such as three investors — Becky, Rachel, and Martin — entering the market to buy a share of Company X, wherein Company X is willing to sell one share of their company in order to increase capital and their net worth through investors.

An Example Exchange in the Market

In this scenario, Company X has no money but owns one share that it would like to sell the open exchange market while Becky has $1,000, Rachel has $500, and Martin has $200 to invest.

If Company X has an Initial Public Offering (IPO) of $30 on the share and Martin buys it, Martin would then have $170 and one share while Company X has $30 and one less share.

If the market booms and Company X’s stock price goes up to $80 per share, then Martin decides to sell his stake in the company to Rachel, Martin would then exit the market with no shares but up $50 from his original net worth to now total $250. At this point, Rachel has $420 left but also acquires that share of Company X, which remains unaffected by the exchange.

Suddenly, the market crashed and Company X stock prices plummet to $15 a share. Rachel decides to opt out of the market before it goes any further down and sells her share to Becky; this places Rachel with no shares at $435, which is down $65 from her initial net worth, and Beck at $985 with Rachel’s stake in the company as part of her net worth, totaling $1,000.

Where the Money Goes

If we’ve done our calculations correctly, the total money lost has to equal the total money gained and the total number of stocks lost has to equal the total number of stocks gained.

Martin, who gained $50, and Company X, who gained $30, have collectively gained $80, while Rachel, who lost $65, and Becky, who is sitting on a $15 investment, collectively lost $80, so no money has entered or left the system. Similarly, AOL’s one stock loss is equal to Becky’s one stock gained.

To calculate the net value of these individuals, at this point, one would have to assume the current stock exchange rate for the stake, then add that to their capital in the bank if the individual owns stock while subtracting the rate from those who are down a share. Company X would, therefore, have a net value of $15, Marvin $250, Rachel $435, and Beck $1000.

In this scenario, Rachel’s lost $65 has gone to Marvin, who gained $50, and to Company X, who has $15 of it.

Further, if you change the value of the stock, the total net amount Company X and Becky are up will be equal to $15, so for every dollar, the stock goes up, Becky will have a net gain of $1 and Company X will have a net loss of $1 — so no money will enter or leave the system when the price changes.

Note that in this situation nobody puts more money in the bank from the down market. Marvin was the big winner, but he made all his money before the market crashed. After he sold the stock to Rachel, he’d have the same amount of money if the stock went to $15 or if it went to $150.

What to Invest in When Market is Falling?

Several strategies can be used when investors believe that this market is about to occur or is occurring; the best approach depends on the investor’s risk tolerance, investment time horizon, and overall objectives.

Selling Out

One of the safest strategies, and the most extreme, is to sell all of your investments and either hold cash or invest the proceeds into much more stable financial instruments, such as short-term government bonds. By doing this, an investor can reduce their exposure to the stock market and minimize the effects of the raging bear.

That said, most, if not all investors, have no ability to time the market with accuracy. Selling everything, also known as capitulation, can cause an investor to miss the rebound and lose out on the upside.

For those who want to profit from a falling market, short positions can be taken in several ways, including short-selling, buying shares of an inverse ETF, or buying speculative put options, all of which will increase in value as the market declines. Note that each of these short strategies also come with their own set of unique risks and limitations.

Playing Defense

For investors looking to maintain positions in the stock market, a defensive strategy is usually taken. This type of strategy involves investing in larger companies with strong balance sheets and a long operational history: stable, large-cap 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.

These so-called defensive stocks also include companies that service the needs of businesses and consumers, such as food purveyors (people still eat even when the economy is in a downturn) or producers of other staples, like toiletries. 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.

Protective Put Options

One big way to play defense is to buy protective put options. Puts are options contracts that give the holder the right, but not the obligation, to sell some security at a pre-determined price on or before the contract expires. So, if you hold 100 shares of the SPY S&P 500 ETF from $250, you can buy the 210 strike puts that expire in 6 months, for which you will have to pay the option’s premium (option price).

In this case, if the SPY falls to $200, you retain the right to sell shares at $210, which means you’ve essentially locked in $210 as your floor and stemmed any further losses. Even if the price of SPY falls to $225, the price of those put options may increase in market value since the strike price is now closer to the market price.

Shopping for Bargains

A bear market can be an opportunity to buy more stocks at cheaper prices. The best way to invest can be a strategy called dollar-cost averaging. Here, you invest a small, fixed amount, say $1,000, in the stock market every month regardless of how bleak the headlines are.

Invest in stocks that have value and that also pay dividends; since dividends account for a big part of gains from equities, owning them makes the bear markets shorter and less painful to weather.

Diversifying your portfolio to include alternative investments whose performance is non-correlated with (that is, contrary to) stock and bond markets is valuable, too. For instance, when stocks crash, bonds tend to rise as investors seek safer assets (although this is not always the case).

These are just two of the more common strategies tailored to a bear market. The most important thing is to understand that a bear market can be a very difficult one for long investors unless they because most stocks fall over the period of a bear market, and most strategies can only limit the amount of downside exposure, not eliminate it.

Why do Investors Lose in the Stock Market Crash?

Many new investors have found that soon after buying their first stock, its value drops. It makes for a disappointing introduction to the world of investing. Still, it can also prove to be a valuable wake-up call, inspiring you to learn everything you can about investing in the markets.

While investing in financial markets over the long-term is an excellent path to wealth, it’s not unusual to experience occasional losses as investment values go up and down.

Here’s what you need to know about why people lose money in the market—and how you can bounce back from a loss in your portfolio.

Not Understanding Market Cycles

People often lose money in the markets because they don’t understand economic and investment market cycles. Business and economic cycles expand and decline.

The boom cycles are fostered by a growing economy, expanding employment, and various other economic factors. As inflation creeps up, prices rise, and GDP growth slows, so too does the stock market decline in value.

Investment markets also rise and fall due to global events. One the first day of trading after 9/11 (Sept 17, 2001), the Dow fell 7.1%, the biggest one-day point loss in the index’s history.

If you sold during the week following 9/11, your investments most likely would have lost money.

But if you’d held fast and done nothing after the decline, you would have been rewarded for your steadiness: Within a month of the attacks, the Dow Jones, Nasdaq, and S&P 500 were back to where they were before the attacks.

Letting Emotions Guide Decision-Making

People lose money in the markets because they let their emotions, mainly fear and greed, drive their investing. Behavioral finance—the marriage of behavioral psychology and behavioral economics—explains why investors make poor decisions.

Understanding basic behavioral finance concepts and learning to manage your emotions can help you avoid a good deal of losses during your investment lifetime.

For example, following the herd mentality is one of the worst behavioral finance mistakes, and it plays out whenever you follow the investing crowd.

Herding in investing occurs when you make investments based on whatever choices “the group” is making, without performing your evaluation of current information.

In the late 1990s, venture capitalists and individual investors were pouring money into internet dot com companies, driving their values sky-high. Most of these companies lacked fundamental financial stability. Investors, afraid of missing out, continued to listen to the popular press and follow the herd with their investment dollars.

A glance at historical S&P 500 stock market returns shows how buying and selling with the herd can damage returns.

Looking to Get Rich Quick

Some people lose money in the markets because they think investing is a get-rich-quick scheme. You can quickly lose your investment dollars by heeding the outrageous claims of penny stock and day-trading strategies.

The most recent Dalbar study of investor behavior found that for 2018, the average investor underperformed the market as a whole for the 25th year in a row (as long as Dalbar has conducted the study).

For 2018, the S&P 500 retreated 4.38%, while the average investor lost 9.42%. The reasons are simple. Investors try to outsmart the markets by practicing frequent buying and selling in an attempt to make superior gains. It rarely works.

To avoid losing money in the markets, tune out the outlandish investment pitches and the promises of riches. As in the fable of the Tortoise and the Hare, a “slow and steady” strategy will win out: Avoid the glamorous “can’t miss” pitches and strategies, and instead stick with proven investment approaches for the long term.

Though you might lose a bit in the short-term, ultimately, the slow-and-steady approach will win the financial race.

Buying on Margin

Another way an investor can lose large amounts of money in a stock market crash is by buying on margin. In this investment strategy, investors borrow money to make a profit.

More specifically, an investor pools their own money along with a very large amount of borrowed money to make a profit on small gains in the stock market. Once the investor sells the position and repays the loan and interest, a small profit will remain.

For example, if an investor borrows $999 from the bank at 5% interest and combines it with $1 of their own savings, that investor will have $1,000 available for investment purposes. If that money is invested in a stock that yields a 6% return, the investor will receive a total of $1,060.

After repaying the loan (with interest), about $11 will be left over as profit. Based on the investor’s personal investment of $1, this would represent a return of more than 1,000%.

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This strategy certainly works if the market goes up, but if the market crashes, the investor will be in a lot of trouble.

For example, if the value of the $1,000 investment drops to $100, the investor will not only lose the dollar he or she contributed personally but will also owe more than $950 to the bank (that’s $950 owed on an initial $1.00 investment by the investor).

Margin and The Depression

In the events leading up to the Great Depression, many investors used very large margin positions to take advantage of this strategy. However, when the depression hit, these investors worsened their overall financial situations because not only did they lose everything they owned, they also owed large amounts of money.

Because lending institutions could not get any money back from investors, many banks had to declare bankruptcy. In order to prevent such events from occurring again, the Securities and Exchange Commission created regulations that prevent investors from taking large positions on margin.

By taking the long-term view when the market realizes a loss and thinking long and hard before buying on margin, an investor can minimize the amount of money they lose in a stock market crash.