When analyzing the market as a whole, you’ve most likely heard the terms “bear market” and “bull market.” You’ve also probably heard how one is essentially “bad” and the other is essentially “good.” But how do you actually analyze these kinds of markets, and how can you position yourself the best way in either one?
Both these types of markets are inevitably going to happen, and as a trader, it’s important to understand what’s happening and what to look for.
Origin of the Bear and Bull Market
“Bear” and “Bull” are commonly used terms to describe market conditions. These market types have an undeniable impact on your portfolio which is why it’s important to understand the key differences and know which market you’re in while thinking about your trading strategy. Knowing which market you’re in affects how you make your trades.
A bull market describes an overall strong economy while a bear market is an economy that represents declining stock value. An easy way to remember the difference between the two is to think about the origins of the names.
The reason why it’s called a bear market is to reflect how bears in the natural world attack their prey. They do so with a downward swipe of the paw. This downward paw swipe is supposed to reflect the downward trend in the economy in this market. Bulls, on the other hand, attack their prey by thrusting up their horns, reflecting the positive trend in the economy during a bull market.
What Happens in a Bear Market?
The very basic definition of a bear market is one that occurs when a market is experiencing securities falling more than 20% from their previous high.
The term generally describes the market overall, but individual securities and commodities can also be considered “in a bull market.” Sometimes, it may be easy to spot bear markets as they may accompany a recession or other poor economic conditions. These poor economic conditions can be a result of low disposable income and declining job opportunities.
Bear markets can also be described as occurring when investors are wearier of taking risks. The time frame of a bear market can vary drastically, however, there are two different types that have been identified that can be used to analyze how long these conditions will last.
There are two different types of bear markets to keep in mind:
- Secular bear market: Investopedia defines this bear market as one lasting more than 10 to 20 years “characterized by below average returns on a sustained basis.” The Balance identified that the most recent secular bear market occurred between October 2007 and February 2009. Many times you’ll see a secular bear market when investor sentiment is weak and stocks are experiencing selling pressure for extended periods of time.
- Cyclical bear market: One that is much shorter than secular markets, lasting only between several weeks to several months. These markets move with macroeconomic conditions, like growing consumer spending. The Nest has identified that stock prices and investor moods remain relatively low for about 400 days on average. Market Watch reported that sometimes during cyclical markets declines can be up to 30%.
What is the Impact of Bear Markets?
There are usually four different phases in a bear market, identifying these phases can impact how you react to this market in terms of protecting your capital. Knowing the different phases can help you strategize the best plan of action for entering or exiting in this market, depending on your trading plan. Many times, despite negative trends, bear markets don’t always pose bad opportunities for all sectors.
The Balance gave a prime example of Warren Buffet maintaining shares of Berkshire Hathaway having the purchasing power of an ounce of gold.
Overall, yes, bear markets occur in stock decline. Bear markets may only be bad if you plan on selling your stock in the short-term, however, bear markets can be beneficial to those with long-term investing strategies.
For long-term investors, bear markets can be opportunities to make fixed investments which can help average out losses overtime when the bear market eases up. This is known as “dollar-cost averaging”.
As an active trader, being aware of strategies like short-selling or buying the dip can provide opportunities to capitalize during bear markets.
The Different Phases of a Bear Market
- Phase 1: Generally begins in a positive light with high investor sentiment with high prices. However, due to these inflated prices, investors may begin to drop out of the markets taking whatever profits they can.
- Phase 2: Characterized by capitulation. This occurs when investors begin to sell due to periods of decline. Investors begin selling as a result of decreased business and earnings. Indicators that were communicating positively are now showing negatively, causing investors to, again, pull out of the markets.
- Phase 3: This occurs when speculators start to enter the markets. Speculators impact the markets by buying as much of a stock based on its perceived demand, ultimately this continues to drive up prices. Conversely, if they believe that an asset is overpriced they’ll try to sell as much of it as possible at the asset’s high.
- Phase 4: Lastly, stock prices continue to decline, but at a very slow rate. Over time, as investors gain confidence again due to lower prices, the bear market will eventually turn into a bull market.
Trading Strategies for Bear Markets
With bear markets being an inevitable part of the stock market, here are some ways to maximize as much profit as possible with little loss. Following are the most common practices for trading in a bear market.
- Buying Puts: InvestorPlace recommends starting off by buying short term and long term puts. Focusing on an options trading strategy, this could lead to higher profits and limited downside. Naked Puts may be very beneficial because the idea here is selling puts that others want to buy in exchange for cash premiums. You collect a premium for the sale of the contract with the idea the stock price will continue to remain under the strike price past expiration. Even in bear markets, there are instances when stock prices will rise, thus benefiting from selling short-term puts. However, overall this a risky strategy to take if you’re not familiar with options trading, and naked puts in of themselves are risky, so take caution when formulating your trading plan.
- Bear Put Spreads: The goal is to profit from a gradual price decline in the underlying stock. The basic strategy here is to buy at-the-money puts and sell out-of-the-money puts. Profits are lower if the stock price falls below the price of the short put lower strike, while, the loss is lowered if the stock price rises above the strike price of the long put or higher strike.
- Short Selling: BullsonWallstreet suggests the idea of short selling because when stocks are down you can borrow shares from a broker and buy them back later at a lower price. Be wary of this strategy, as your losses can go beyond what you have in your account, making you indebted to the broker.
- Buying Bounces: Bear markets offer lots of volatility. Stocks in a bear market won’t go straight down forever. Usually, when stocks are overextended on the downside they usually have nice bounces. The idea here is a quick trend move to quickly take profits, this isn’t something to take to the long-term, another trading strategy suggested by BullsonWallstreet.
What Happens in a Bull Market?
Bull markets are characterized by more psychological aspects such as when investors have strong feelings about positive market trends continuing for extended periods of time. In general bull markets are characterized by a 20% increase in stock prices, just after a 20% decline, seen in bear markets, and right before a second 20% decline.
Just as a bear market occurs most commonly after phenomena such as a recession, bull markets can be predicted to happen in reflection to rising GDP. Other indicators of a bull market are strong corporate profits, rise of IPOs, and overall investor confidence. A Bull market will be indicated by a rise in all three major market indexes like the S&P 500 and Dow Jones Industrial Average. The most recent Bull market is actually the longest in history, beginning in March of 2009 and ending in March of 2020
- Secular Bull Markets: Describes a bull market that has a 5 to 25-year trend. It is still possible to see a downwards trend of about 10%, but never drops to the point of entering a bear market. These secular markets can have smaller bear markets within them, known as primary market trends, and can happen quite often.
Impact of Bull Markets on your Trading
It’s also important to take into consideration the supply and demand trends occurring in a bull market. In a Bull market there is strong demand but little supply. With little stock to buy, stock prices increase as a result of investors holding onto their shares.
When the economy enters into a bear market, almost always a bull market will be preceding. Bear markets can give you great insight into how impactful the bull market will be on your portfolio. The bigger the losses in a bear market the bigger the gains in a bull market.
Another important factor to be wary of when considering entering/exiting during a bull market is the fact that even though everyone is buying and the economy is good, this doesn’t necessarily always mean that everything is good. It may be unwise to buy just because stocks are cheap. The best way to have a positive impact on your portfolio is to think in terms of growing wealth long-term.
Trading Strategies for Bull Markets
- Buying Calls: InvestorPlace says one of the more common practices for options traders. Buying calls are beneficial because the buyer anticipates the stock moving up in price, and once it does they have the ability to sell the option before it expires. The biggest concern with this is knowing when the option is going to expire and to sell before it does so.
- Retracements: Investopedia also suggests another strategy, maybe for more aggressive traders. Watch for those downward trends that tend to happen in bull markets, buying additional shares, and then knowing that the market will generally continue an upward trend, they hope to sell at a higher price.
- Full Swing Trading: Another method suggested by Investopedia for more aggressive traders. This entails more closely monitoring the back and forth movements in the bull market. When using this strategy it’s important to pay close attention to momentum oscillators. This strategy takes a short-selling approach by buying long, taking those profits, and selling short. Since bull markets offer longer uptrends, buying longer and selling short is a commonly used strategy.
Overall, both markets offer their fair share of advantages and disadvantages. The most important thing to remember when trading in these types of markets is the risk you’re willing to take on. It’s also beneficial to keep in mind underlying factors that can incite an oncoming bull or bear market, such as investor psychology and macro events, such as a pandemic.
The best way to understand how to formulate your trading strategy to fit into each of these inevitable markets is to do your research. Benzinga Pro helps you find fast market news that can indicate where trends are heading. Start your FREE 2-week trial, no credit card needed, to get access to a lightning-fast Newsfeed, historical data, daily charts, price trends and more.
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