A bear market is one of the most dreaded events in the world of stock trading. It can cause investor confidence to plunge to an extremely low level and make investing risky even for the most experienced traders. During a bear market, many investors rush to sell off their stocks in an attempt to avoid further losses, resulting in a devastating cycle of negativity. Inexperienced traders who don’t know what is a bear in the stock market may suffer lingering effects that last for years when they encounter one.
If you’re a beginner trader, you should have a good idea of what a bear market means and how to survive or even profit from it. Below is a comprehensive guide that can help you become a successful bear investor.
- What Is a Bear Market?
- What Causes a Bear Market?
- What Are the Phases of a Bear Market?
- What Is the Difference Between a Bull Market and Bear Market?
- How to Identify a Bear Market
- How to Survive and Prosper in a Bear Market
What Is a Bear Market?
Different people may define a bear market differently. However, the general notion of what makes a bear market is a situation in which stock prices drop at least 20% from recent highs and investor sentiment is negative. Usually, a bear market happens as a result of an overall decline in the stock market, but specific stocks may also enter into bear market territory if they fall at least 20% over two months or more.
In the United States, the most recent prolonged bear economy took place during the Financial Crisis, which lasted from 2007 to 2009. It went on for 17 months and caused the S&P 500 to lose 50% of its value.
What Causes a Bear Market?
There are many factors that can lead to a bear market, including:
- Weak or sluggish economy: A bear market often occurs as a result of a weak, sluggish, or slowing economy. Some of the signs of a struggling or declining economy include low disposable income, low employment rate, weak productivity, and falling business profits.
- Government economic intervention: Government intervention in the economy, such as changes in the federal funds rate or tax rate, may also trigger a bear market.
- Low investor confidence: A decline in investor confidence may indicate the beginning of a bear market. When a large number of investors anticipate something bad happening, they’ll sell off their shares to avoid losses, which may result in a bear market.
What Are the Phases of a Bear Market?
Knowing what happens in a bear market can help you better prepare yourself to overcome the challenges and take advantage of the opportunities it presents. Typically, a bear market has four phases, which include:
- First phase: Stock prices and investor sentiment are high in the first phase of a bear market. After making good profits, investors are likely to drop out of the stock market, which marks the end of this phase.
- Second phase: During this phase, stock prices start to drop sharply, corporate profits and trading activity begin to decline, and economic indicators fall to below-average levels. Some investors may start to panic, resulting in lower sentiment. The second phase of a bear market is called capitulation.
- Third phase: In the third phase, speculators begin to enter the stock market, causing some stock prices and overall trading volume to rise.
- Fourth phase: In the final phase, stock prices keep falling at a slow pace. As a result of the low prices, many investors return to the market, facilitating the transition from a bear market to a bull market.
What Is the Difference Between a Bull Market and Bear Market?
There are only two conditions that describe the overall state of the stock market: bull market and bear market. It’s essential to know what is meant by bull and bear in the stock market because you need to implement different strategies for each of the two situations. The best way to understand the difference between a bull market and bear market is to see them as the opposite of one another. Below are the main differences in a bull market versus bear market comparison:
- Performance: One of the main conditions that define a bull market is a rise in the overall performance of the stock market. A bear market occurs when market performance is on the decline.
- Investor sentiment: Another way to determine whether the stock market is bull or bear is to look at investor sentiment. In a bull market, investors are typically optimistic and tend to take longer positions in the market. However, they’re more likely to take short positions during a bear market as their outlook becomes more pessimistic.
- Stock prices: Stock prices rise during a bull market, giving investors more opportunities to maximize their profits. In a bear market, prices will continue to fall, which causes investors to sell their shares and undertake put positions.
- Market indicators: Another notable bear-bull market difference is that a bull market causes market indicators to become very strong, while a bear market results in weak indicators.
- Trading activity: Liquidity in the stock market is very high during a bull market, leading to increased trading activity. In a bear market, investors are more reluctant to make commitments as liquidity dries up.
- Security and dividend yields: This is another significant bear vs. bull market difference. Security and dividend yields will be low during a bull market, which shows the financial strength of the securities and investors. These yields will be very high during a bear market, indicating a need for funds and an attempt to lure investors.
How to Identify a Bear Market
With knowledge of the difference between a bear and bull in the stock market, you’ll be more capable of answering the question, “Are we currently in a bull or bear market?” However, there are specific conditions you need to look out for in order to accurately identify whether the current stock market is a bull or bear market. Below are a few factors you should take into consideration when trying to understand what is bear market territory:
- Major stock indexes: A bear market takes place when the major stock indexes continue to drop over time and hit new lows. Additionally, they’ll make lower highs.
- Duration and frequency: From 1900 to 2008, bear markets happened 32 times, each of which lasted an average of 367 days. They occurred once every three years.
- Recession: To determine what’s a bear market, you have to see if the economy is undergoing a recession. A bear market typically occurs during a recession, when the economy experiences stagnant growth and then contracts. High unemployment rates are one of the obvious signs of a recession.
- Business cycle: Another way to identify what is a bear market in stocks is to look at the economy’s position in the business cycle. If the economy is entering the expansion phase, it’s unlikely that a bear market will happen. However, if it’s experiencing an asset bubble or irrational exuberance among investors is increasing, it’s probably the beginning of the contraction phase, meaning a bear market will ensue.
How to Survive and Prosper in a Bear Market
If you ask investors, “Is a bear market good?” you’ll more often than not get a negative answer. However, if you truly understand what is meant by a bear market, you can leverage certain situations and tools to minimize your losses and maximize your gains. The following is a list of tips for making a bear market more bearable and profitable:
- Choose the right stocks to buy: Invest in the stocks of good companies. Both good and bad stocks tend to fall during a bear market, but good stocks will recover faster.
- Invest in dividend stocks: The prices of stocks drop because of selling, but their issuing companies may still be strong, earning good profits, and paying dividends. Look for such companies and purchase their dividend stocks.
- Use bond ratings to identify gems: Bond ratings give you an insight into the creditworthiness of companies. Companies with ratings of AAA, AA, and A are regarded as “investment-grade” companies. Investing in these companies is an effective way to mitigate your risks.
- Buy defensive stocks: When the economy is entering a recession, you can play it safe by buying defensive stocks. Companies that issue these stocks produce or sell products such as food, beverages, and utilities, which continue to be in demand during a recession.
- Purchase call options: The great thing about buying call options is that they can be very cheap during a bear market. If the price of a stock is falling sharply but the issuing company is generating solid profits, there’s a good chance that the stock will rebound soon.
With a better understanding of a bear market, you can arm yourself with the right tools and strategies to tame the bear in the stock market. By turning yourself into a nimble investor, you can take advantage of the unique opportunities a bear market presents to boost your profits and build a solid foundation for long-term growth. If you want to learn more about bulls and bears in the stock market or other aspects of stock trading, sign up for our free, seven-day RangingBull BootCamp to get profitable tips from our successful trading experts.