What is a bear market?
You've probably heard of "bulls" and "bears" before. Indeed, traders and players in the financial world are used to using Wall Street jargon and talking about bull markets and bear markets to describe the state of shape of the equity markets.
If you've been following the news closely in these special times, you will know that many markets have entered bear market territory. But what is it exactly?
After our article last week on the bull market , discover today everything you need to know about the definition of the bear market.
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Bear Market Definition
A bear market corresponds to a period when price declines persist.
Stock price declines are 20% or more from most recent highs and these are fueled by pessimism or negative market sentiment.
Bear markets are most often associated with declines on a global market or on a particular index such as the BEL 20 or the CAC 40.
Individual securities or commodities can also be found in a bear market if a drop in their course of 20% or more is saved for a long time.
We're talking about two months or more here. Bear markets can also go hand in hand with a decline in the global economy, such as a recession.
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The definition of a bear market
There is no precise definition of a bear market, but generally speaking, it refers to a considerable and incessant decline in the value of securities.
Most institutions define a bear market as a decline in an equity market of 20% or more for a period of at least two months.
As mentioned above, bear markets sometimes go hand in hand with recessions, i.e. times when the economy is growing at a standstill and the economy is contracting, which translates into an unemployment rate. raised.
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You can recognize a bear market if you know what business cycle the economy is in. If it has just entered a recovery phase, then a bear market is unlikely.
On the other hand, if the business cycle is going through a bubble or if investors are irrationally exuberant then a wise investor will be attentive to the first signs of a bear market.
The name bear market refers to a bear which when attacking always does so from the top down while the bull market refers to a bull which lowers its horns before lifting them up.
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What does a bear market tell us?
Generally speaking, stock prices reflect future expectations for companies' earnings and profits. As growth prospects and forecasts diminish, stock prices may in turn decline.
Because of the herd behavior, fear and haste of investors who want to protect themselves against losses, prices plunge and stock market crashes cannot be ruled out.
Remember, we are talking about a bear market if there is a decline of more than 20% from the highest level, but this definition is not universal.
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We must not be blinded by these famous 20% but also take into account other factors. Thus, a trader can take an interest in the behavior of investors.
In a bear market, many investors tend to avoid risk rather than seek it out. They then turn to safer investments such as government bonds or gold and refrain from any risky speculation.
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Bear markets can be triggered by various factors such as a weakened or slowing economy with a low labor force ratio, limited growth in GDP, a decline in production or even a decline in corporate profits.
A drop in investor confidence can also signal the start of a bear market. When they have a bad presentiment, investors kick in.
They start selling their stocks to avoid losses. This type of market can last just a few weeks or several years. Corrections are possible but these are not strong enough and prices fall to ever lower levels.
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A cyclical bear market (this is a bear market that does not go hand in hand with a weakened economy), on the other hand, can last from a few weeks to several months.
In March 2020, the coronavirus pandemic suddenly plunged stocks around the world into a bear market, causing a global stock market crash.
Let's take a closer look at what actually happens when equity markets are in bear mode.
- Stock prices continue to decline. As soon as the market is bearish, the path becomes bumpy. Volatility is key, which means stocks can fall quickly.
- Investors are worried and they are panicking. When investors are afraid of taking risks and afraid of losing money, then this means that the bears have taken over the market. Bear markets are moving much faster than bull markets. This is explained by human psychology.
- The unemployment rate is on the rise. A bear market is usually synonymous with a sluggish economy, which means that companies hire less quickly or worse yet, are forced to lay off staff.
- Consumer confidence is declining and businesses are struggling. People start saving because they lost their jobs and they have to focus on basic necessities. A reduction in household spending is unfavorable for businesses because some of them no longer manage to make a profit or maintain an acceptable level of productivity.
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The phases of a bear market
Bear markets go through four different phases. These are detailed below.
- The first phase is characterized by high prices and a rather confident sentiment among investors. At the end of this phase, investors begin to exit the markets and take their profits.
- During the second phase, stock prices begin to fall sharply. Business activity and profits are declining and economic indicators that were positive are below average. Some investors panic when ske
- pticism sets in in the markets. We then speak of capitulation.
- The third phase is marked by the arrival of speculators on the markets. These increase the prices and the volume traded. They are often novices who do not know much about the market.
- During the fourth and final phase, stock prices continue to decline, but at a somewhat slower pace. Low prices and good news are ultimately bringing investors back to the markets. The bear markets are then transformed into bull markets.
A bear market versus a correction
We must not confuse a bear market and a correction. A correction is a short-lived trend of less than two months.
While a correction may well be a precious time for investors looking to find an entry point into a bull market, bear markets very rarely offer suitable entry points.
The reason is that it is almost impossible to determine the bottom of a bear market. Unless you are a short seller or are using other strategies to earn profits in bear markets,
it is strongly recommended not to buy stocks in a bear market. Try for example to catch a falling knife. You might be lucky to catch him by the handle just as you could hurt yourself badly.
How to react to a bear market?
Investors can make profits in a down market through short selling. This technique involves selling borrowed stocks and subsequently buying them back at a much lower price.
This is an extremely risky transaction and at a loss if it fails.
A short seller must borrow the shares from a broker or counterparty before they can place a short order.
The amount of the short seller's profit or loss is the difference between the price at which the shares were sold and the price of their repurchase.
Example of a bear market
An investor short sells 100 shares of a company for $ 50. The price drops and the shares are hedged up to € 40. The investor makes a profit of € 10 x 100 = € 1,000.
If the stock suddenly trades at a higher price, then the investor is forced to buy back the stock at a higher price. The losses can therefore be considerable.
You can prepare for a bear market by reducing the risk of your investment portfolio. For example, you can reduce the number of growth stocks you hold.
You can also select bonds or underlying funds which usually perform better in a bear market.
Think, for example, of gold funds or sector funds that focus on the health sector and the consumer staples sector.
For more information on short selling, feel free to visit our website . Diversification can also help protect you from the dire consequences of a bear market.
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