Contrary to what many believe, our experience confirms that reversion to the mean in the stock market works best during a bear market. This may seem counterintuitive, but the reason is increased volatility. And perhaps even more paradoxical is that short selling works better than short selling!
In 2008/2009, we were day trading and made the most money on the long side even though the market was down over 50%.
The speed of a bear market creates opportunities. A bleak future fades quickly, while the opposite, a bull market, rises slowly over time. The stock market spends much more time above its 200-day moving average than it does below it.
Perhaps most importantly, bear market rallies are explosive. We have published some of the data on the global financial crisis in other articles, but we repeat it now:
From May 2008 through early March 2009, the S&P 500 lost about 50% of its value. However, let's look at these numbers:
There were 99 up days and 104 down days during that period.
The average daily increase was 1.79%, while the average daily decrease was -2.32%.
From May 2008 to early March 2009, there were 51 days with >1% up, 30 days with >2% up, 76 days with >1% losses, and 45 days with >2% losses.
The market has fallen, but we are still seeing many explosive days on the upside. This makes short selling difficult, but it also makes buying weakness and selling strength very profitable. Most of our monthly Trading Edge trades make the most money in bear markets!
Short-term trading requires prey, and that comes in the form of volatility. The chart below shows the 25-day moving average of absolute values in daily changes from close to close:
