The terms “bear” and “bull” are believed to originate from the actions of the animals themselves. A bull attacks by thrusting its horns upward, while a bear attacks downward. This action was then adopted as a metaphor for markets, with an upward trend signifying a ‘bull market’, and a downward trend being labeled as a ‘bear market’.
Also, the term ‘bull’ stands in stark contrast to ‘bear’, stemming from the traditional blood sport of pitting bulls and bears against each other.
These symbolic actions represent how traders hold differing views on how the market will move going forward.
What Is a Bear Market?
A bear market is a term used to describe an economic climate where stock prices have drastically dropped, typically by 20% or more from their peak over the last few months. This can occur as a result of an economic slowdown or an extraordinary event. Such examples are the recent history of Coronavirus pandemic, or the Great Depression.
An alternate definition of a bear market is when investors move away from risky investments in favor of safe, stable options. This shift away from speculation can continue for an extended period of time, with the bear market lasting months or even years. This continues until investors regain enough confidence to start taking risks again.
Individual securities or commodities can also fall into a bear market if they experience downward price movements of 20% or greater over a sustained period of time, usually two months or more.
A bear market can be an extremely difficult time for investors, as it indicates a period of uncertainty and instability in the economy.
During bear markets, investors are likely to face incredibly difficult experiences. Stock prices can plummet drastically and valuable investments may become virtually unusable. Thus, understanding how best to handle such an environment is key for maintaining financial stability.
What causes a bear market?
The effects of a bear market can be far-reaching, stretching across different sectors and industries. Consumers may spend less due to a lack of disposable income, which can cause businesses to go bankrupt as their own profits suffer. In turn, this has a significant impact on the labor force—jobs become scarce as firms are forced to reduce their workforce.
Decreases in government spending also contribute to the ripple effect of a bear market, resulting in reduced investments in infrastructure and services that adversely affect citizens’ quality of life.
While it is difficult to predict when a bear market occurs, taking steps to prepare for it such as diversifying investments and setting up emergency funds can help protect against potential financial losses.
Characteristics of a Bear Market
Signs of a bear market include:
Stock Market Declines.
Wall Street is no stranger to volatility, and a bear market demonstrates that in spades. These markets are characterized by extended periods of decline – 20% or more on major indexes such as the S&P 500 Index or Dow Jones Industrial Average – which can prove devastating for investors who don’t prepare accordingly.
Economic Decline.
Economic downturns are commonly characterized by rising unemployment, falling GDP, and decreasing corporate profits.
Negative Investor Sentiment.
When the stock market enters a bear market, many investors become pessimistic about their expectations of the future. As a result, they may choose to sell their assets rather than continue to hold them, leading to a decrease in demand and a subsequent drop in prices. This pessimistic attitude also causes some investors to move away from stocks and into safer investments like bonds. By selling or moving funds out of stocks during a bear market, investors can protect their capital from further losses.
Duration.
Bear markets are a difficult reality for many investors and can cause uncertainty in an economy.
Bear markets typically last for at least two months. However, on average, these periods of decline tend to linger for about 10 months.
However, this timeline can vary according to overall macroeconomic conditions; if there is greater economic turmoil when compared with a more stable environment then the risk of further extended bear markets increases. Understanding how financial markets behave and preparing in advance can help to reduce losses and ensure long-term success.
Phases of a Bear Market
A bear market is a complex reality for investors and the economy alike. By understanding its phases, one can gain remarkable insight into how to navigate these tumultuous times.
The first phase – High prices and High Investor Sentiment
The first phase of a bear market, investors are often overly optimistic and stock prices show signs of unsustainable increases. This stage is known as the Bull Market Top – an important marker in any bear market cycle.
Investors are currently optimistic while viewing the market in a positive light. This enthusiasm leads many to invest, believing that prices will only continue rising; however, as this phase winds down some wise investors begin taking their profits and leaving the scene.
The Second phase – Stock Price Declines
The second phase of a bear market, characterized by sharp stock price declines, is when the market starts to see an increasing number of negative economic indicators such as decreased trading activity, declining corporate profits, and falling GDP.
During this stage, some investors may start to panic about the overall market. This will cause them to start selling off their assets in an attempt to limit their losses.
This stage also sees negative sentiment spread throughout the market, as investors become more pessimistic about the market’s prospects.
Third Phase – Price Raise
The third phase is characterized by speculators entering the market, some of them may take advantage of the low prices to buy stocks. This increased buying activity can cause some prices to rise, and trading volume to increase.
However, it is important to note that this activity is not driven by long-term investors, but rather by those looking to make a quick profit.
Fourth Phase – Continued Stock Price Decline
The fourth phase is characterized by a continuation of falling stock prices on stock markets but at a slower pace. Prices continue to fall, but positive economic indicators such as increasing corporate profits and GDP may start to appear.
This slow decline in prices and an improvement in economic indicators can attract investors back into the market. An event which can ultimately lead to a potential bull market.
It’s important to note that these phases are not necessarily linear. The progression and duration can vary depending on the underlying economic conditions. Additionally, not all bear markets occur by following these four phases. These phases may overlap, hence these are general overviews and not hard rules.
