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Bear Market

Bear MarketA bear market belongs to the primary market trends, together with the bull market, market top, and market bottom.

What Is a Bear Market?

It is the term used to describe the overall decline of the stock market. The trend got its name from the way a bear attacks its prey, i.e. by moving downward. It is typically opposed to the bull market, which is used to describe the upward trend and got its name from the bull attacking with the upward movement. The market trend can be considered as “bear” at the time when the price of securities falls by 20%. When the decline is between 10 and 20%, it is considered a correction.

During a BM, the stock market can post gains for days or even weeks. This is known as a bear market rally and it can easily trick many investors into thinking that the BM is over and a new bull market has started. During a BM, there can be days or even months when the trend can go up. But if it is still lower than 20%, it is a bear market.

A BM is typically triggered by slowdowns in a country’s economy, e.g. high unemployment rates and low business profits. It may take about a week for a bear market to start. Additionally, any intervention by the government in the economy, such as tax rate changes, can also cause a BM. Finally, a decline in investor confidence can contribute to a BM as well.

Duration of Bear Markets

Depending on how long they last, there are two main types of BMs: secular and cyclical (regular). Secular markets can last 10 – 20 years and are characterized by below average returns on a sustained basis. Cyclical or regular markets last from a few weeks to several years. Bear markets are typically shorter than bull markets. Here are some examples of BMs, in chronological order:

  • 1929: occurred after the Wall Street Crash of 1929 and marked the start of the Great Depression.

  • 1937 – 1942: after regaining nearly 50% of its losses, a new BM cut the market in half again.

  • 1973 – 1983: another long-lasting bear market occurred, caused by the 1970s energy crisis and high unemployment of the early 1980s.

  • 1987: a market crash with a 29.6% decline occurred, lasting about 3 months.

  • 2007 - 2009: the recent long-lasting BM occurred during the financial and lasted for about 17 months.

  • On December 24, 2018, the US major market indexes fell into the BM territory.

The average length of BMs since 1926 is 1.4 years, with an average decline of 41%.

Bear Market Stages

A BM typically goes through the following four stages:

  1. High prices and high investor sentiment (the general mood among investors regarding a certain asset). By the end of this phase, investors begin to sell their shares in order to avoid losses.
  2. Stock prices, trading activity, corporate profits, and economic indexes such as the Dow Jones Industrial Average and the S&P 500 begins to drop. Some investors begin to panic as sentiment starts to fall. This is called capitulation.
  3. Speculators start to enter the market, therefore raising some prices and trading volume.
  4. Stock prices continue to drop, but slowly. Because of low prices, the investors become more optimistic, and BMs transform into bull markets.

How to Benefit from Bear Markets

Investors can use BMs to their own advantage. Specifically, there are three ways to benefit from BMs:

  • Short selling. This method involves selling borrowed shares and then purchasing them again at lower prices. During the short selling, an investor must borrow the shares from a broker before a short sell order is placed. A difference between the price at which the shares were sold and the price at which they were bought back (covered) is the short seller’s profit and loss amount. For example, an investor short sells 100 shares of a stock at $85. The price falls and the shares are covered at $70. As a result, the investor’s profit is $15 x 100 = $1,500. However, if the price unexpectedly goes up, the investor must buy back the shares at a premium, thus carrying a heavy loss.

  • Put options. With a put option, the owner has the right but is not obliged to sell a stock at a certain price on or before a specific date. It is possible to use put options for speculation on falling stock prices and hedging against the falling prices. Only investors with the option privileges in their accounts can make such trades.
  • Inverse exchange traded funds (ETFs). Inverse ETFs change the values in the opposite

direction of the index that they are tracking. For example, an inverse ETF for the S&P 500 will grow by 1% if the S&P 500 index drops by 1%. Leveraged inverse ETFs can increase the returns of the tracked index by 2 and 3 times. Same way as options, it is possible to use inverse ETFs for speculation or hedging.

Summary

A bear market characterizes a decline in a stock market that is higher than 20%. The main reasons that may cause a BM are slowdowns in the economy, government intrusions in the economy, and loss of investors’ confidence towards specific assets. There are two main types of BMs: secular (long lasting) and cyclical (short lasting). Since 1926, an average bear market lasted 1.4 years, with an average decline of 41%.

There are 4 stages of a BM:

  1. High prices and high investor sentiment.

  2. A drop in stock prices, trading activity, corporate profits, and economic indexes.

  3. Speculators start to enter the market.

  4. Stock prices continue to drop, but slowly.

At the end of a bear market, the bull market trend begins – this term indicates the upward trend. The most common ways to invest in BMs are short selling, put options, and inverse exchange-traded funds.