What is a Bear Market?

Understanding Bear Markets

Stock prices as one might know reflect the general expectations of profits from a given company. Note that when companies struggle to grow and the expectations of said companies or the market itself decline this can cause stocks to decline to lead to a bear market.

As mentioned before bear markets are often present when securities decline 20% or more but the numerical value does not in fact matter it is more of a benchmark for traders or in other terms and despite numerical concerns, a Bear market can be seen as a market where investors are less likely to invest due to risk rather than more likely due to less risk. This kind of bear market can last for even longer periods as investors do not look for high-risk investments but rather avoid them in favor of more confident investments (less risky/guaranteed return).

There are many causes for bear markets ranging from low economic downturns, a slow market, bursting market bubbles, wars, pandemics/outbreaks of disease, geopolitical crises, etc. Signs that also may indicate an incoming bear market may consist of a low overall disposable income, low employment rates, low productivity amongst companies, waning buying momentum, and large drops in business expectations/profits. Notably, a drop in investor confidence can also signal a bear market, for example, when investors predict or see that something negatively affecting their shares is going to happen a majority sell to avoid losses potentially causing a bear market. Government intervention by certain means might also be the cause of a bear market.

As aforementioned a bear market can last for weeks, months, and even years but when a bear market lasts for 10 to 20 years we call this a secular bear market which yields low returns over a grand period of time. Yes, one can still make a profit during a secular bear market but these gains to not sustain for very long as prices will eventually descend to a lower value. Contrary to secular bear markets there are cyclical bear markets that last a few weeks or several months.

Note that in a Bear market demand is lower than supply, fewer people want to buy the shares that are available causing a decrease in the market.

Phases of a Bear Market

There are 4 main phases to a bear market, though this is not how a bear market is always caused this is a common sequence of events that pretense one. The first phase of a bear market often consists of investors selling off a multitude of their investments due to higher than normal prices to make a profit.

The second phase consists of sharply declining stock prices as a result of phase one, declining trade activity, and certain economic indicators that showed a positive now dropping below averages. The third phase yields many speculations which occasionally raise prices and trader activity. Finally, the fourth and final phase shows stock prices dropping but not at alarming rates. Rather they drop slowly. This will eventually lead to good news or certain types of news that end up influencing investors to get back in which causes bear markets to eventually turn into bull markets and vice versa.

Bear Markets vs. Corrections

Bear markets and corrections are very different. Corrections are not long-term but rather short term only lasting a couple of weeks but often only fewer than 2 months. In addition, corrections are often labelled as a 10% decline in a stock’s price from its local highs which is seen several times per year.

Corrections offer many good opportunities for investors to enter the market whereas bear markets have opportunities but they are quite rare and often not stable. This is because it is not easy to determine a bear market’s bottom making it harder for investors to determine when it may be the right time to enter if at all as unless one is shorting in a bear market losses can be very hard to recover.

Short Selling in Bear Markets

During a bear market, there are few ways to make profits but short selling can open a gateway toward gains. Short selling is the process of selling borrowed shares a buying them back at lower prices to give one a better position. Although, this is a risky way of trading and can result in a high loss if it does not work in the investor’s favor. Regardless of risk note that a short seller must borrow the shares before short selling. The investor’s profit can be calculated or seen as the difference between the price where the shares were liquidated and the price where they were bought again, this can be referred to as the covered amount.