A Detailed Explanation and Definition of a Bear Market

DailyForex.com Team

A bear market and a bull market are phrases most people have heard before, but what is a bear market? Most investors fear a bear market. They run for the exits, hoard cash, and hope their portfolio allocations can weather the storm. Understanding the bear market meaning will help alleviate fear and allow investors to navigate a bear market with bear market investing strategies capable of delivering long-term profitability.

Many fear a bear market because investor confidence is low, earnings weak, and economic indicators often contract, stocking fears of a potential recession, which could feed the downward spiral. A bear market is an unavoidable part of investing. On a positive note, a bear market is less frequent than a bull market, has a notably shorter duration, and creates highly profitable long-term investment opportunities.

What is the Bear Market Definition?

The bear market definition is a 20% contraction from the most recent high of an asset, usually measured by the closing value. While the bear market meaning primarily applies to an index, like the S&P 500, or a sector, like technology, the same principle applies to individual assets, where market participants use the term bear market less frequently.

It is essential to remember that the 20% correction forms only one part of the bear market definition, as time also fulfills a crucial role. While there is no unanimous agreement, most refer to a bear market if price action remains 20% off for several weeks. A market temporarily dropping 20% can fall under the terminology of a correction, usually defined as a 10% downward move from recent highs.

With many focused on the 20% correction, investors must consider the signs pointing toward a bear market, as it does not happen overnight. Smart money makes portfolio adjustments and applies bear market strategies as the bear market forms, and not after price action meets the bear market definition. 

Here are several signs pointing toward a pending bear market:

  • Price action fails to make or sustain fresh highs following a significant advance
  • The market moves higher on fundamentally negative news as investors dismiss them
  • Positive days come on the back of low trading volumes, while negative days have high trading volumes
  • A series of lower highs forms over several weeks
  • Signs of economic distress, like persistent high inflation or inverted bond yield curves, exist
  • Bullish sentiment is excessive and disconnected from fundamentals
  • Sectors vital for economic growth, for example, transportation, fail to confirm highs in the broader market or start to sell-off
  • Central banks indicate monetary tightening, placing stress on debt-heavy industries like technology

Understanding how a Bear Market works

Before answering “what does bear market mean for my portfolio,” investors must differentiate between a secular and a cyclical bear market. 

What is the difference between a secular and cyclical bear market?

A secular bear market - A secular bear market can last years or decades, is extremely rare, and results in below-average returns. Investors are risk-averse, seeking the security of safe-haven instruments, prefer cash over investments, and economic performance remains sluggish or interrupted by a crisis. 

A cyclical bear market - A cyclical bear market appears more frequently and lasts from several weeks to a few months. It often presents a healthy correction from lofty levels and allows investors to take advantage of highly profitable opportunities, often once in a decade investment scenarios.

Financial markets move in cycles, expanding during bull markets and contracting during bear markets. Sometimes they oscillate in tight trading ranges representing neither market condition outright but reflecting short-term bullish or bearish sentiment, with neither side able to gain the upper hand.During a bear market, investor confidence is low, and financial markets make lower highs and lower lows, confirmed by increased trading volume during down days. The process takes several months and is often interrupted by a bear market rally, when prices advance and often result in a bull trap, when retail traders and bullish mutual funds buy the dip, anticipating a reversal. Price action moves higher, fails to sustain the uptrend, and often results in a more massive sell-off and lower low. It usually takes a notable change to break the herd behavior in either direction. Financial markets require a sustainable catalyst to end a bear market. It must improve earnings and outlooks for companies, supported by robust economic growth and healthy consumer spending.

A Bear Market Example

Besides the current bear market which the global financial system currently experiences, with inflation not seen since World War II, and earnings disappointment magnified by depressing outlooks, supply chain disruptions, contracting consumer confidence, a land war in continental Europe, and a slowing economy, the last notable bear market began in 2007 and lasted through 2009.  The bear market of 2007 was a product of the global financial crisis and began in the US housing sector, the most regulated sector of the US financial system. Market participants ignored ample warnings signs about the mortgage crisis as equity markets rallied to fresh all-time highs. Investors and traders discounted economic warnings, cheering the ongoing rise in housing values, a significant wealth trap, and bullish sentiment dominated daily trading activities.

Once the housing bubble burst and mortgage defaults spiked, well-known financial institutions like Lehman Brothers and Bear Sterns collapsed. It resulted in forced, government-instructed takeovers of other firms like Morgan Stanley and massive tax-funded government bailouts. US markets tanked 50%+, sending ripple effects throughout the global financial system. Many international banks and asset managers jumped on the US housing bandwagon, causing trillions of losses during a violent bear market. The March 2009 bear market low ignited a sharp equity market rally, rewarding patient investors who bought into the heavy sell-off. Central banks created an artificial bull market with easy monetary policy, resulting in the longest-lasting bull market in US history, briefly interrupted by the technical bear market caused by the Covid-19 pandemic. 

After a sharp 33% sell-off, investors and traders pushed markets to fresh all-time highs, which created what appears as a massive bull trap as it ushered in a new bear market. Some fear it could burst the “everything bubble” created by central banks and dwarf the 2007-2009 bear market. The scenario is ideal for the current bear market to last several months and potentially longer. Investors should consider bear market investing, as the bear vs. bull market cycles will continue to provide opportunities.

The Four Phases of a Bear Market

Evaluating any bear market history, including our bear market example above, reveals four phases usually present in every bear market.

  • Phase one consists of bullish sentiment and financial markets moving higher, but with low trading volume and limited market-breadth
  • Phase two results in an initial sharp sell-off, like a bear attacking its prey by violently swiping its claws downward
  • Phase three often creates a bull trap, with markets rising amid misplaced optimism the bear market is over, causing sharp rallies like a bull thrusting its horns in the air
  • Phase four witnesses lower lows, but the downward move remains measured and calmer as markets attempt to form a bottom and fundamentals improve

Investors should consider that the third phase and fourth phase can repeat numerous times during a cyclical bear market but may last years or decades during a secular bear market.

What is the Difference Between a Bear Market and a Bear Market Rally?

We have covered the difference between bull and bear market conditions. Investors must also recognize a bear market rally, which occurs when price action moves swiftly higher during a bear market. It usually creates the third phase of a bear market, where traders and long-only mutual funds push markets higher on expanding trading volumes. It appears as if the bear market nears its end. Some confuse a bear market rally with a fresh bull market and fall victim to a bull trap. Unlike a bull market, where markets reach all-time highs, during a bear market rally, markets move higher until they reach a significant resistance level from where a reversal takes price action to new bear market lows. Bear market rallies offer skilled traders a short-term opportunity to the upside and an attractive short-selling opportunity to capture the downside.

Bear Market vs. Bull Market Comparison

What is a bear market, and what is a bull market? Understanding and recognizing the market condition will increase your portfolio performance, and below are the key facts to consider.

What is a bear market?

  • Investor sentiment is low, and consumer confidence depressed
  • Risk aversion elevated
  • Economic indicators point toward a slowing economy
  • Corporate earnings are contracting, and outlooks remain negative
  • Trading volume is higher on down days
  • Markets reach lower highs and set lower lows
  • A 20% correction lasting at least two months but potentially years
  • Bear market rallies and bull traps as markets move lower

What is a bull market?

  • Investor sentiment is high, and consumer confidence increases
  • Risk appetite elevated
  • Economic indicators confirm an expanding economy
  • Corporate earnings beat expectations, and outlooks are positive
  • Trading volume is higher during up days
  • Markets reach higher highs and set higher lows
  • A 20% rally lasting at least two months but potentially years
  • Bull market sell-offs and bear traps as markets move higher

How to make Money in a Bear Market?

Bear market investing strategies allow long-term investors to benefit from bear markets, and bear market trading strategies provide short-term traders with opportunities. Below are some ideas to consider.

How to make money in a bear market as a long-term investor?

  • Dollar-cost averaging
  • Portfolio diversification
  • Overweight in sectors that outperform during recessions
  • Long-term focus without worrying about short-term market fluctuations
  • Ensure portfolio composition fits investment goal and adjust if necessary

How to make money in a bear market as a short-term trader?

  • Sell the bear market rallies
  • Utilize put options and inverse ETFs
  • Monitor price action closely with a focus on trading volume and sentiment
  • Stock-picking rather than a broad-based focus can increase profitability
  • Follow trading strategies and execute proper risk management

Bear Market Conclusion

A bear market is no different than a bull market, except price action moves in the opposite direction. Investors can follow bear market investing strategies for long-term portfolio growth, and traders can benefit from short-term trading strategies. Bear market investing can result in once-in-a-decade buying opportunities as financial markets have recovered from each bear market. Investors must consider where in their investment cycle they are and make portfolio adjustments if necessary. Rather than fearing a bear market, which is a necessary part of financial markets, investors and traders should understand how to recognize the market condition and execute appropriate bear market strategies. A bear market offers profitable opportunities like a bull market. Regrettably, many market participants associate fear with a bear market and opportunity with a bull market, missing the broader picture in financial markets.

FAQs

Is a bear market a good market?

Any market is good if investors and traders recognize the market conditions and deploy appropriate strategies.

How long will a crypto bear market last?

Bear market crypto conditions can last years, like bear markets in other sectors.

How do you profit from a bear market?

Short-selling bear market rallies, put options, inverse ETFs, and focused trading strategies are four ways to profit from a bear market as a trader. Investors can generate profits from a bear market by using dollar-cost averaging, executing their long-term focus, being overweight in sectors that perform well during recessions, and ensuring portfolios are weighted correctly versus their investment goals.

When was the last bear market?

The last bear market occurred in March 2020 due to the coronavirus panic but lasted only a short while as markets recovered quickly and strongly.

When will the bear market start?

A bear market usually starts when investor sentiment is high, while markets reach new all-time highs on low trading volumes and limited market breadth.

DailyForex.com Team
The DailyForex.com team is comprised of analysts and researchers from around the world who watch the market throughout the day to provide you with unique perspectives and helpful analysis that can help improve your Forex trading.

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