Bear Market Hedging Strategy

A Simple Bear Market Hedge: A Strategy for Downturns

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Most traders focus on making money in bullish markets, but what happens when the market turns south? Traditional long strategies struggle in bear markets, often leaving traders sidelined or taking unnecessary risks. While Alpha Crunching primarily focuses on high-probability and frequency bullish trades, these setups tend to be scarce in prolonged downturns.

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That’s where a dedicated bearish strategy comes in. This approach provides an effective way to stay active and profitable during market declines without relying on complex hedging instruments or costly short positions. Using simple moving average conditions, strategic strike selection, and disciplined profit-taking, this trade has historically performed well in bear market years while staying mostly inactive during bullish periods.

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In this post, I’ll break down the logic behind this bear market hedge, how it works, and why it can serve as a great companion strategy when bullish trades aren’t available. Let’s dive in.

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Defining a Bear Market and the Trade Setup

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Before diving into the trade itself, we need a clear and objective way to define when a bear market is in play. While many sources define a bear market as a 20% drop from recent highs, that definition is more reactive than practical for trading. Instead, we’ll use a straightforward technical rule:

• A bear market is confirmed when the 10-day simple moving average (SMA) crosses below the 200-day SMA on the SPX daily chart.

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This moving average crossover acts as a trend filter, ensuring we only take trades when the broader market is in a sustained downtrend. Once this condition is met, we look for individual trade entries based on a secondary filter.

• We only take trades on Mondays, and only if SPX is trading below its 10-day SMA at the time of entry.

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This second condition prevents us from shorting into bear market rallies, which are common during prolonged downtrends. By waiting for SPX to be below the short-term trend (10SMA), we increase the probability that the downward momentum is intact rather than fading.

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This setup ensures we are only trading in true bear market conditions and avoiding false signals that could lead to unnecessary losses. Below is an example chart illustrating these two conditions in action:

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With these conditions in place, let’s move on to the trade itself—how we select strikes, manage risk, and take profits.

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Trade Execution: Strike Selection and Profit Taking

Now that we’ve defined when we take trades, let’s break down the specifics of how we enter, manage, and exit positions.

Recap of the Technical Setup

• Day of the Week: Trades are only taken on Mondays.
• Entry Time: About an hour before the market close (3 PM ET).
• Market Conditions: SPX must be in a bear market (10SMA below 200SMA) and trading below its 10SMA at the time of entry.

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Strike Selection and Trade Mechanics

• Strategy: At-the-money (ATM) bear call spread on SPX.
• Expiration: 14 days to expiration (DTE).
• Short Strike: Near Delta 50, ensuring the spread is positioned at the current price level.
• Premium Received: Typically around $2.50 per spread for a $5-wide spread (risking $2.50 per spread).

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By selling an ATM bear call spread, we create a defined-risk trade that benefits from declining or sideways movement in SPX.

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Profit Taking and Risk Management

• Profit Target: We take profits at 50% of max gain, which equates to $1.25 per spread (locking in gains of around $125 per contract).
• Holding to Expiration: If the profit target isn’t hit, we let the position play out until expiration. There is no stop loss, as the spread is risk-defined.

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This rules-based approach eliminates emotion and allows the math to work in our favor over time. Since 2017, the strategy has maintained a 77% win rate, with:

• Average Win: $139
• Average Loss: $236

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These results reflect the natural edge that comes from selling premium in bear markets, as volatility tends to stay elevated. The combination of a strong technical filter, well-placed spreads, and a systematic exit strategy has allowed this setup to be consistently profitable in market downturns.

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Next, let's take a look at the Annual Metrics for this strategy from 2017-2024.

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Annual Performance and Portfolio Context

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To put this strategy into perspective, let’s look at how it performed in various market conditions over the past several years. While no strategy is perfect, this one has shown the ability to generate solid gains in bear markets while staying on the sidelines during bullish years.

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For this example, we’re assuming a $100K account, allocating 2% per trade. This is not a recommendation, but rather a way to illustrate how a small allocation can still make a meaningful impact in volatile market environments.

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Performance by Year

• 2017: No trades – bullish conditions kept this strategy on the sidelines.
• 2018: A volatile year, producing a +4% portfolio gain while only risking 2% per trade.
• 2019: No trades – another bullish year despite coming out the end of 2018 downturn.
• 2020: The COVID crash provided prime conditions, adding nearly +4% in gains from this strategy.
• 2021: No trades – another strong bull market year.
• 2022: The bear market, largely driven by rate hikes, resulted in the strategy’s best year, up +6.5%.
• 2023: A small loss of less than 0.5%, reinforcing that no strategy is bulletproof, but the impact was minimal.

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Final Thoughts

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This strategy isn’t meant to replace a core trading system but rather to serve as a hedging tool in bearish environments. By only taking trades when the market is in a confirmed downtrend and using a strict risk-defined approach, it provides an additional edge during tough years. The limited trading frequency also means it doesn’t overcomplicate a broader trading plan—staying out of the market when conditions aren’t favorable.

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For traders using primarily bullish strategies, having a complementary bearish approach like this can help smooth portfolio performance during downturns. While no strategy guarantees profits, adding a systematic bear market hedge can reduce overall volatility and provide a way to stay engaged in all market environments.

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