What is a bear market?
A bear market is a market with an extended decline in prices of goods and services. The decline is due to the pessimistic sentiments from investors about the economy and future growth in general. As a result, many investors sell their holdings for profits or to protect their portfolio in case the market slides.
Securities’ prices must fall at least 20% from the recent high to be a bear market. Bear markets are the opposite of bull markets where prices of goods and services increase at an extended period of time.
Table of contents
- What are the causes of bear markets?
- The difference between a bear market and a market correction
- Phases of a bear market
- How to trade and invest in a bear market?
- The impact of a bear market on investments
1. What are the causes of bear markets?
The main cause of bear markets is the economy. When the economy is slowing down, investors become risk-averse.
In these conditions, the number of new investments and job creations decreases.
The following are some of the signs of bear markets.
- Low employment: The employment rate provides a big picture of how the economy is doing. It shows whether companies are hiring or laying off employees. Low employment suggests that companies are not interested in increasing the number of workforces. Without an increase in clients or demand in general, it would not make sense for companies to hire more people and expand.
- A decrease in productivity: Manufacturing companies increase or decrease their productivity based on demand. The demand also dictates how fast companies expand and locations of expansions. With fewer customers, companies will reduce their productivity to create a balance between supply and demand.
- Low disposable income: People make less money during economic hardship and they tend to manage their income wisely. With a high level of uncertainty in the economy, disposable income will be diminished. Savings, debts, and vital expenses are taken care of first. This leads to little to no disposable income at all.
- A decrease in businesses’ profits: The decline in the number of customers or quantities of orders directly affects companies’ revenues and earnings. You would expect revenues to decrease during bad economic conditions.
- Government interventions in the economy: Governments all of the world closely monitor their economies to make sure that they are accelerating at desirable rates. Most of the time, the economic conditions get better without the government stepping in. However, there are times when domestic and international economic conditions worsen to a level where governments have to intervene.
2. The difference between a bear market and a market correction
When the market slides, many investors think it is a bear market. However, every market crash is not a bear market. A market correction is one where the market loses around 10% from the previous high.
On the other hand, the market must lose at least 20% from the previous high to be a bear market. To learn more about bear markets and market correction follow this link.
3. Phases of a bear market
It is understandable that the market does not crash and hit the bottom all of a sudden. There are always fluctuations in prices as people buy and sell goods and services.
The following are the main phases of a bear market.
Phase 1: High prices of goods and services
You probably heard in the news investors saying that the stock market indexes are making new highs. Or the markets are at all-time highs.
This means that investors’ sentiments increased to a level where prices of good and services are expensive. This does not stop there. They keep buying.
However, those who know what they are doing cautiously exit the market. Someone once said that what goes up eventually comes back down.
This means that at some point many people will realize that the prices of goods and services no longer make sense. That is when the crash begins.
Phase 2: A sharp decline in the prices of goods and services
The sharp decline is due to a huge number of people selling. Sellers overwhelm buyers and this creates an imbalance on supply and demand rule.
Do you remember what happened during the corona-virus pandemic when the Dow lost 3000 points in a single trading day? Everyone wanted to sell. Unfortunately, no one wanted to buy.
What happens when you place your market order in a bad market and does not get filled in like 3 min? Panic takes over and investors start selling at whatever price possible which exacerbates the market sell-off. Market exchanges use circuit breakers to prevent sellers from crushing markets in a single day.
Phase 3: More buying from speculators
I started by saying that the market does not drop all the way to the bottom. This is true because, after a sharp sell-off, speculators think that the market has reached the bottom. I cannot blame them.
What would you do when your favorite stock lost over 40% in one week? I think you can buy a few shares at a $40% discount saying that it cannot go any lower.
When speculators enter the market, we observe a brief reversal in the current trend. Their actions increase trading volumes in the uptrend and prices increase.
Phase 4: A slow drop in the prices of goods and services
Finally, this is the phase everyone was waiting for. The last phase. A phase that determines whether you are an investor or playing in the market. This phase will help you enter at the right time.
I am talking about the bottom. Yeah, everything that falls always hits the ground.
Actions of speculators in phase 3 does not turn a bear market into a bullish one. Eventually, they lose the momentum and stocks fall one more time.
The fall is sharp but not as sharp and fast as we saw in phase 2. This fall usually makes a new bottom. That is it breaks the low of the previous low.
When the selloff is over, the stock start rebounding gradually or fast depending on how fast they dropped.
Of course it takes a time to replace a pessimistic sentiment into a optimistic one.
4. How to trade and invest in a bear market?
A bear market does not mean that you stopped eating or taking care of your family. If you trade for a living; you would still have to trade to make a living.
Your family must eat as usual and they can only do that if you made money. This means that you will still go to work.
The question is, how will you trade knowing that there are high chances that you will lose money in the stock market?
The answer is there you may not lose money in the stock market during a bear market.
You only need to change your trading strategies and trade like a pro.
The following are few tips to help you trade during a bear market.
Tips for long term Investing
Tip 1: Invest in $401(k)
The 401(k) is not immune to the collapse of the market. The retirement funds follow the market trend during the crash.
However, they are safer than individual stocks. Techniques you use on your 401(k) will determine whether you succeed or lose like everybody else.
One of the best ways to do it is to buy index funds through your 401(k). Index funds you buy rebound later on and therefore, give you back the money you lost during the crash.
Tip 2: Invest for the long run near or at the bottom
What goes down always hits the bottom and bounces back up. I think someone said that. This means the bear market will end and bulls will take over.
It is difficult to time the market or know exactly when the market will hit the bottom.
For this reason, put your money into the best stocks and securities once the market is at or near the bottom. You will always gain once the market rebounds.
The stocks and securities you pick will determine your success after the crash. You must remember that some stocks and securities do not bounce back. Some of them go bankrupt and others never rebound to their previous highs.
Tip 3: Sell losers
How do you decide a loser if everything is losing? Good question. When the market crashes stocks and securities do not crash the same way.
Losers will tend to drop much faster with high percentages losses compared to good ones.
Stocks of companies that never make profits or with bad balance sheets are the ones to fall deeper into the hole. You can analyze the fundamentals and ratios of every company you have in your portfolio. Or the ones you want to invest in. If numbers are looking bad from every corner, you know these companies will tank more during the crash.
These companies also do not do good during regular market conditions. You can get rid of them and buy them later if they show signs of improvements.
Tip 4: Invest in stocks and securities that move against the market
Have you ever heard a saying that your problems are someone else answers? This is exactly what happens in the market.
To give you an example, look at what happened during the coronavirus pandemic. There are novices who think that every stock lost during the pandemic. The answer is no. There are stocks that boomed because of the virus.
These are stocks in industries that were not directly affected. How? Some people out there argue that every industry was affected in some how. That is true. But some were affected and gained at the same time.
For example, companies that are in hygienic services gained a lot. I don’t mean companies that come and clean your carpet when you move out of your apartment.
I mean companies that make paper products, antibacterial products, and related services, etc. What about companies in online communications. I mean online conferencing.
The point here is that people had to rely on these online conferencing companies to stay in touch and continue their activities.
I know you want a real-life example. There is a company that you probably know by now. It goes by this ticker: ZM. Did you know about it before the pandemic? If you ask this question on the street, you will see that almost everyone did not know about it.
What do you think happened when the virus hit? Everyone stayed home and schools continued.
What does this have to do with our Zoom? The company grew more than 300% and still growing. Why would this happen? Because everyone is using it.
As an investor, you can take advantage of stocks and other securities that move against the market to make profits.
Short selling means that you borrow shares of a stock from your broker and sell them at the current market price. Your goal is to buy the same number of shares at a cheap price and return them to your broker.
You have to make sure that the price of a stock will go down in the future. Remember, you make a profit only when the stock or security goes down.
Your profit will be the difference between the buying and sale prices.
Example of short selling
Let us say that there is a stock you know for sure will go down. Let’s also assume that it is trading at $10 per share. So, you decided to borrow and sell 1000 shares at a total sale of $10,000. This transaction will show in your account as the money you ow your broker.
For the next few minutes, days, or even months, the stock moves down all the way to $4 per share.
You think you made enough profit now and decided to exit your position.
What will you do? you will buy all 1000 shares at $4 dollars each. The total cost will be $4000.
The difference between the sale price of $10,000 and the purchase price of $4000 for the same number of shares is $6,000. This $6,000 will be your profit.
Tip 6: Diversify your portfolio
Diversification will save your portfolio whether you are in a bear market or not. When you diversify your holdings, you increase your chances of winning across many sectors.
That is, you buy stocks and other securities from different and unrelated sectors to protect yourself against the market crash. There is a high chance that one or more sectors will not crash with the market. Even if all of them crash, they will not crash at the same rate.
Tips for short-term traders during a bear market
Tip 1. Short stocks
This is the first advice I can give you. If you know the market is in a long term decline and have all confirmations you need; why not short stocks.
Shorting is the best route and you can make a discent profit if you play it safe.
You can check an example I provided above regarding shorting stocks and other related securities.
Shorting can be done for long term or shorter term depending on your investment strategies and your broker’s terms. Keep in mind that you will need a margin account to be able to short stocks. If your account is a cash account, you can upgrade to a margin account.
If you choose the shorting route; you must get out of the market before the market rebounds. This will protect you from sudden losses depending on when you took your positions.
You must also follow properer trading and investing strategies such as using limit orders, diversification, hedging, stop losses, etc. Shorting is dangerous and you should not use it if you are not an experienced trader.
Tip 2. Join speculators on the 3rd phase of a bear market
Well, I always encourage people to be careful and be certain when trading. Speculating the market is not the best thing you can do. However, unless you are an insider trader which is illegal, you are speculating.
I mean it. Nobody knows the future and therefore, decisions we make during our trading experiences are all speculative. Of course, you will increase your odds of winning by doing your homework.
That is, researching the company before you buy shares in it, know the market conditions before investing, knowing how to use technical analysis, etc.
It is true that speculators create a brief reversal in the market. You can make a small profit by joining them.
If you choose this route, you must get out of the market before sellers take over again.
Tip 3: USE stop-loss orders ALL the time.
Sorry to use cap letters. I wanted to make sure that you get it before you continue your readings.
The purpose of a stop loss is to kick you out of the market and sell a specified number of shares at a specified price if the market goes against you.
Stop losses are very important when trading. They protect you from major losses.
When bears are out of the mountains and roaming in cities, you must know that the stock you are trading could lose 30% easily.
I don’t think you want 30% of your portfolio to evaporate just like that.
To protect yourself, always use stop-loss orders.
Tip 4. USE limit orders ALL the time
This is another important thing to consider. Always use limit orders.
A limit order means that you want to buy a stock or security at a predetermined price. That means you decide how much you pay per share. Your orders will be filled only at a price you specified.
A limit order will give you the shares you want at a price you want to pay. What do you think would happen if you place a market order to buy a stock at $7 per share and it gets filled at $17 per share? I will let you answer that question.
You must understand that there is a chance that all your shares will not be filled when you use a limit order. In addition, you might not get any shares at all if the price does not reach your specified limit.
There is always a cost for everything beautiful. This is the price you pay for using a limit order. Limit orders can be used when buying or selling.
Why would you need a limit order?
The answer: VOLATILITY. Volatility will sometimes be your best friend or your enemy.
In simple words, volatility is how fast prices and volume of a particular stock are changing in a given period of time.
During the market crash, the volatility is high. This means you can easily lose 50% or more on your portfolio in a matter of minutes.
As a short term trader, you want to get out of the market faster than investors do.
To make sure that you do not get out with a huge loss, use limit orders all the time.
5. The impact of a bear market on investments
Bear markets are famous for three things. 1. Crashing investors’ portfolios. 2. Causing companies’ bankruptcies. 3. Creating huge opportunities for value investors and long term traders.
A bear market affects negatively all investments especially those related to sectors being hit the most. For example, a stock market crash will affect almost every sector in the market. If you have an investment in the stock market, expect to have a big decline in the value of your portfolio.
This decline in investment also reduces businesses’ values as they lose customers, cut jobs, and reduce their outputs. As a result, their revenues and earnings decrease.
Depending on the duration of the bear market, some businesses survive while others go bankrupt.
This creates opportunities for long term traders and value investors.
Every investment is based on a simple and yet complex idea. Buy low and sell high.
When the market is at its lowest point, long term investors and traders jump in and grab all undervalued stocks, companies, and other securities. They help revive the market with their money and reap a big profit in return.
Final words
Think of your portfolio as prey that every predator wants to devour. If you don’t use proper methods, your portfolio will be reduced to ashes faster. You must survive the storm. The faster you lose hope, the faster you get wiped out of the market.
Invest wisely and watch your account grow.
You are one step closer to your success.
Good Luck Trading and Investing!
