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Confessions of a Bear Market Survivor

It's starting to look like this brutal bear market might be slowly coming to an end. I've actually seen a few stocks gain two or three days in a row and the drops don't seem a far. We may not have the stellar stock gains of the past but the market seems to be done with the head spinning, portfolio wrecking, declines.

Did you survive the Bear Market?

I survived and I've been dipping my toe back in, adding holdings to my portfolio over the last month or so. Not a lot. Not yet, anyway. The main thing is… I survived what will probably be remembered as one of the worst stock market drops in history.

How did I do it? What did I learn?

Read on for my full confession....


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Sure I took some lumps over the last few years. My WorldCom stock isn't worth the postage for my broker to mail me the actual stock certificates and who ever thought that Intel or AOL would drift below fifteen dollars?

But I learned a few things along the way?

1. Keep some cash on hand.
I kept enough cash on hand to meet any unforeseen needs. A large part of my portfolio was in cash (CDs, short term bonds, Money Markets) so when I had to get a new car and repair our front porch the cash was there. I didn't need to jump in and sell under priced stock to raise money.

2. Invest in real companies.
For the most part (except for PriceLine and Puma - we all make mistakes) I only invested in companies with real income, profits, and strong balance sheets. During the last few years these type of companies (UPS, ERTS, MSFT, etc...) took a beating but they did not go down as much as the others. And... They'll come back. Don't invest in companies based on advertising, hype, a hot new product, or because it's next great thing. Make sure it's a real company.

3. When you think a stock can't drop anymore... It does!
Looking back, I religiously bought a few shares of nice looking stocks on the drops. I figured they couldn't drop much further. Oracle (ORCL) and Motorola (MOT) come to mind. It's not necessarily a buy signal when a stock drops 20% in one day then goes up a few pennies the next day. Only buy into a stock that looks solid.

4. When to sell.
Looking back, I think we can all say that we should have sold all our stocks on January 7th, 2000. On that day, the Nasdaq 100 Tracking Stock (QQQ) was 87.87, now it's at 21.69. That's over a 75% drop. But we didn't know about number three above, yet. How can it drop any further? So here's my new hard and fast rule... No mater what, if a stock drops 10%, dump it. Don't hold it a minute more because it can easily drop another 50% before you know it. I might give up some potential winners going through a bad stretch but I'll take that risk now.

5. Don't even think about buying a stock without hedging.
One of the reasons I made it through the last few years whole is that I had most of my portfolio hedged with options. And even during the worst of the declines, I continued to use options to generate cash in my portfolio. Even now that things are starting to look a little better I will not take a position in a company without hedging it. Here's an example:

A few weeks ago when the market was up, I had my eye on a stock. Let’s call it XYZ (a fictitious stock). Lots of good news coming out of the company, solid numbers, strong market position and the charts looked like the stock was on a rally. It seemed ready to go up. I was tempted to buy the stock at 26.58 (the price ten months ago was 46.18) but instead I used a strategy known as a Bull-Call Spread to hedge into the stock. Today XYZ hit 24.13, down 2.45 ( 9.22%) from the day I would have bought it. That's close enough to a 10% drop for me... Time to get out of this stock before things get worse. I bailed on my position and took an 80 cent a share loss or $800 total. If I had bought the stock instead of using the Bull-Call hedge I would have lost $2,450. I saved $1,650 by using the hedge.

It works the other way, too. If the stock would have gone up, I would have made a much higher percent return with the Bull-Call than by holding the stock. If XYZ would have gone up to $30, I would have made an 88.68% return with the Bull-Call but only a 12.87% return with the stock.

Why would anyone ever invest without hedging?

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All stocks and options shown are examples only. These are not recommendations to buy or sell any security. The examples above do not take into account your trade size, brokerage commissions or taxes which will effect actual investment returns. Stocks and options involve risk and are not suitable for all investors and investing in options carries substantial risk. Prior to buying or selling options, a person must receive a copy of Characteristics and Risks of Standardized Options available at http://www.cboe.com/Resources/Intro.asp.