A market is said to be in a bear market when prices continue to drop over time. Typically, it refers to a scenario in which widespread pessimism and unfavorable investor sentiment cause securities values to decline by 20% or more from recent highs. Bear markets are frequently connected with drops in an entire market or index like the S&P 500, but individual stocks or commodities can also be categorized as being in a bear market if they suffer a decline of 20% or more over a prolonged period of time, usually two months or more. Bear markets can also occur in conjunction with broader economic downturns like a recession. Bull markets that are moving upward can be contrasted with bear markets.
Bear Markets Explained
Company cash flows and profit projections are a major factor in stock pricing. Stock prices may fall when growth expectations are not met. The protracted periods of low asset values that can result from herd behavior, panic, and the rush to protect against potential losses can be quite damaging.
If stock prices are down by 20% on average from their previous high, then the market is said to be in a bear market. Please note that 20% is an arbitrary percentage, just as 10% decline is artificial baseline for a correction. Bear markets can also be defined as periods in which investors are less eager to take risks than they were previously. A bear market can endure for a long time if investors avoid risky investments in favor of safer ones.
A weak or lagging or sluggish economy, collapsing market bubbles, socio and geopolitical tension, are all elements that may create a bear market. Low employment, low discretionary income, low productivity, and falling firm profitability are common indicators of an economic slowdown or contraction. A bear market can also be sparked by government involvement in the economy, such the Fed hiking interest rates at a very high pace.
A bear market can also be sparked by government involvement in the economy, such the Fed hiking interest rates at a very high pace. For instance, a bear market might be triggered by a shift in the tax rate or the federal funds rate.
A decline in investor confidence may potentially signal the beginning of a bear market. When investors anticipate negative outcomes, they often sell off holdings to mitigate their exposure to those outcomes.
A bear market is characterized by long-term, below-average returns and could last for months or even years.
Bull and bear market stages
Typically, four distinct times or phases will pass during a bear market.
In this first stage, prices are high and investor confidence is high. By this point, investors had started cashing out their gains and leaving the markets.
The second phase is characterized by a precipitous decline in stock prices, a slowing of trade activity and corporate earnings, and a general deterioration in economic indices that were previously positive. Negative emotion causes some investors to panic. That's called "capping out" on a fight.
In the third stage, speculators begin to enter the market, driving up some prices and trading volume.
The fourth and final phase is characterized by a gradual decline in stock values. Low prices and encouraging news entice investors again, and bear markets give way to bull runs.
Comparing bear markets and corrections
A bear market is a longer-term trend than a correction, which typically lasts less than two months. Value investors sometimes find favorable entry opportunities into the stock market during market corrections, but this is not always the case during down markets. This obstacle exists because finding the bottom of a bear market is extremely difficult. Recouping losses might be difficult unless an investor is a short seller or employs another strategy that results in gains in declining markets.
Bear market short selling
Bear market investors can benefit from short selling. Using this strategy, investors borrow money to buy shares and then sell them at a reduced price. It's a high-stakes gamble that can very costly if done incorrectly. When placing a short sell order, a short seller must first borrow the shares from a broker. The short seller's profit and loss is the difference between the price at which the shares were sold and the price at which they were repurchased, which is referred to as buy to cover, or short covering.
For example, let's say a trader short sells 100 shares of XYZ stock at $56. If price moves up they lose money. If price moves down, they make After a few days stock price starts moving lower and eventually drops down to $46. At that point, the trader chooses to close the position and issues a buy-to-cover order to their broker. The short selling position is closed and the shares are automatically repurchase (by the broker who lend them in the first place) at a price of $46. This results in a profit of $1,000 for the short sell trader ($10 x 100 shares = $1000).
Additional short selling strategies
Bear markets typically call for the use of put options and inverse exchange traded funds.
The owner of a put option has the right, but not the obligation, to sell a stock at a certain price on or before a specified date. Long-only portfolios can be protected from a drop in stock value by purchasing put options and using them to wager on a drop in stock price. Options trading is only available to account holders who have been granted trading access. Unless the market is in a bear phase, putting money on the sidelines is a safer bet than short selling.
Inverse ETFs are a trading vehicle that can used profitably during bear markets.
The value of an inverse ETF is meant to move in the opposite direction of the index that it tracks. For example if the S&P 500 index drops by 2%, the inverse ETF for the S&P 500 would rise, roughly, by 2%. Many inverse ETFs use leverage to increase returns by a factor of two or three above the underlying index. Just like with options, inverse ETFs can be utilized for speculative purposes or to hedge existing holdings.
Recent Historical Examples of Bear Markets
- 2000 Dot-Com bubble. Another instance is the period between March 2000 and October 2002, when the value of the S&P 500 fell by roughly 49% due to the bursting of the dot-com bubble.
- 2008 Financial crisis due to the escalating mortgage default problem. On October 2007, the S&P 500 hit a record high near $1,600. On March 2009 had lost more than 50% of dropping to around $700 on March 2009.
- 2020 Coronavirus Pandemic. At the beginning of 2020, the COVID-19 pandemic triggered widespread lockdowns and the concern of lowered consumer demand, both of which weighed heavily on stock prices. In a short amount of time, the Dow Jones dropped from near-record highs of 30,000 to lows of 19,000. The index lost 34% of its value in just over a month.