What Is A Bear Market

Warren Buffet said, “ After all, you only find out who is swimming naked when the tide goes out.” It is a famous quote by a legendary investor. To be honest, I cannot find any better context to explain what is a bear market.

When the market is high with stock prices up, up, and up — everyone is too optimistic. Everybody starts owning a stock. It seems investing in any equity is the sure formula for minting money. It is a promising economy. You get fantastic returns. Swim baby!

Until the tide goes out.

On an abrupt morning, you wake up to find your portfolio in the dreaded red territory! You become frustrated to see the stock prices plunging with each passing day.

You may even think it to be a temporary market correction and choose to ignore it. To make matters worse, you may even decide to buy on dips to average out.

Which, unfortunately, does not work out as expected.

Day by day, your portfolio plunges more into the abyss. It seems there is no end to this fall. The prices even shoot up for a day or two to trap many speculators.

But ultimately negative sentiments prevail in the market. Key indices fall sharply.

Get ready to welcome Mr. Bear!

Because this volatile and turbulent market condition is nothing but the bear market.

What Is A Bear Market

Bear Market is the condition when the price of most securities suffer almost a free fall in a volatile way. Moreover, there is a widespread negative sentiment about the economy.

In general, bear markets are a long term and volatile phenomenon.

As the bear strengthens its grip, the market participants start panicking. With widespread sell-off of securities, the prices continue to fall in a chain reaction. Investors become risk-averse. They tend to move towards safer instruments.

On average, the stock prices fall at least 20% of their high in a Bear Market.

How did the Bear Market get its name?

It is a common belief that the bear market got its name from the way the animal attacks with its paws downward. As stock prices fall in a volatile bear market, it has close semblance with the bear attacking its prey!

Is A Bear Market Same as Market Correction

Mind that a bear market is not the same as short term market corrections. Corrections are short term phases in a stock market. Usually, market corrections offer fantastic entry points for generating profit. Bear markets do not.

This is because bear markets do not offer any real and measurable bottom. It will make you believe that the entire economy is falling apart. The market players remain clueless and in complete grip of panic. Nobody considers the fundamental value of stocks. In short, the stock market sees a stiff sell-off of most equities.

What Causes A Bear Market

Investors’ fear is the chief cause of a Bear Market.

While there can be many situations triggering the fear, I have jotted down some of the common causes:

• Expected weak and sluggish economy.
• Unemployment.
• Lower productivity and profit.
• Natural calamities.
• Widespread health hazards.
• Geopolitical tensions.
• The intervention of the regulators.

Phases Of A Bear Market

A typical Bear Market has the following predictable phases.

1. It all begins with a hard to believe but false bull rally. In this phase, stock prices are high. Investor sentiment is high. The economy seems to be booming.
2. Towards the end of this rally phase, prices start falling. Traders and investors start booking the profit. This is often confused with a market correction.
3. In the next phase, the fall in stock prices become very sharp. Volume and indicators also turn dismal. Investors start panicking.
4. In this phase of a Bear Market, speculators (should we call them gamblers?) enter the market. They mistake this as a perfect opportunity for entry. This leads to a temporary increase in volume and price.
5. In the final phase, stock prices continue to drop even though speculators try to gamble their hard earned money. This is because there is no real impetus to improve market sentiment.
6. And with rock bottom stock prices, long term investors reenter the market. Gradual economic recovery leads to the end of a bear market.

How to identify a bear market?

Now that we know what is a bear market, let us see how to identify a bear market from the stock charts.

For illustration, we will use the infamous Dow Jones crash of 1929. In general, a bear market will look like the chart below.

Bear Market Chart

If you observe the above stock chart carefully, you can see the following patterns in a Bear Market chart:

• The graph starts at the top left corner of the chart.
• The graph ends near the bottom right corner during the period.
• Another curious feature that you will find on a Bear market stock pattern is, it is never uniform. This is because a bear market is always volatile in nature. Unlike a Bull Market, a Bear Market is a fast-moving and turbulent stock market phenomenon.

Let us dive a little deeper into these charts.

Apart from the visual chart pattern, let me tell you how a bear market behaves quantitatively. If you study the chart pattern of any Bear Market, you will find that most of the time -

1. The price movement will tend to remain below the 50 days moving average.
2. Moreover, the 50-day moving average will be lower than the 200-day moving average.

So, what does this signify?

In a bear market, the index moves from the top left corner to the down right corner of your graph. The tide settles down. And, as Warren Buffet had said, the Bear Market lets you see who was, actually, swimming naked.

Trading Strategies in a Bear Market

Bears are not very friendly animals to tame! It is never easy to make a profit in a bear market. Mark my words, a Bear Market never gives you the right entry point for investment.

This is because you can not guess the bottom. You may find yourself trapped inside a well with slippery walls and no base. I have a first-hand experience of this horrible state!

If you still try to make a profit in a Bear Market, you can apply the following Bear Market trading strategies. I will not discuss these strategies in minute details in this article on what is a bear market. Let me park it for some for future!

This is a common technique used by traders to make a profit with equity whose price is falling. In short, short sell refers to the practice of selling stocks first and buying them later. In other words, you borrow the equities first. Sell them when the price is higher. As the price lowers down, you buy back and return to the lender.

You make a profit if you can sell high and buy low. When you short it out, this is exactly what happens in a falling price scenario.

But, is there a chance to lose money with this technique? Absolutely. As the Bear Market is a volatile phenomenon, there is a high chance that you get trapped in an upward spike.

If you find the price increases as you short sell, exit your position fast. This will ensure your loss is less.

Value investing is the strategy of buying quality stocks when their price is low. While this is a solid strategy to make a handsome profit in the stock market, be careful. Value investment may not work in a Bear Market scenario.

In particular, you will often find that whatever you thought to be a value pick actually will turn into a value trap.

But, careful analysis of the fundamentals can help you spot great opportunities. You must be ready to hold on to the stock for long, though.

As we saw earlier, a bear market is volatile in nature. You will see cyclical and repeated rallies and dips in a bear market cycle. If you can time the market and ride on its ups and downs, you can make some profit.

But this is more suitable for the seasoned market participants. If you are a newbie, it is not an easy task to time a rapid and volatile Bear Market.

And, as you can guess, none of these strategies are suitable for the novice. If you are not a seasoned trader, better to avoid the Bear Market. As for me, I prefer to keep whatever I have than losing everything in guessing and gambling.

Finally, Then What is a Bear Market?

In this post, I tried to explain what is a bear market and what are its main phases. We also saw some of the well-known techniques to make a profit in a bear market.

Let me reiterate the definition of a Bear Market once more.

A bear market is the volatile state of a stock market with a consistent drop in the share price. It reflects a dismal perception of the economy. Investors are afraid. In general, they even ignore the fundamentals of stocks.

Stocks trade at rock bottom prices. Yet, a Bear Market never offers you the perfect entry point for making a profit. You can, of course, try out any of the strategies I mentioned above. But, if you are a cautious investor or new to the market, avoid buying at the dips.

Unless you know what you are doing.

A word of disclaimer here: I am not a professional market analyst. I am not a famous stock market maestro either. As with other articles on this blog, this is my personal take and knowledge about what is a bear market. If you decide to apply any of these strategies here (or reject!), do with your own judgment. Be aware that any equity investment has a certain risk involved. If you are not sure, you can consult any finance experts for advice.

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Originally published at https://www.bulltales.com.