A bear market can affect any tradable asset at any given time. Financial markets will often head in a particular direction for a lengthy period. Just as there are bull markets, one can easily find oneself in a bear market. The conditions are very different, yet it remains possible to make money.
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Understanding Financial Market Trends
A financial market, such as stocks, can often be divided into three possible sentiment phases:
- Bear market: prices go down continually with no immediate recovery. This label applies when a market loses 20% in value in a matter of hours or days.
- Bull market: prices go up continually without any pullback. This label applies when a market gains 20% in value in a matter of hours or days.
- Sideways trading: prices remain virtually unchanged for a lengthy period, which can last days, weeks, or months. This label applies when price changes are below 1% per day.
Every financial market will go through the various stages regularly, creating a “market cycle”. Contrary to what some may think, these market cycles will occur again and again. The order in which they take place can differ. Still, overall, every asset will see a bearish, bullish, and sideways period.
All of the market cycles correlate with investors’ expectations and predictions for that particular asset. Additionally, the overall trading volume – or liquidity – of a market can influence cycles in a big way. More often than not, traders’ expectations are influenced by external events, including new regulatory measures, political tension, and developments affecting the financial sector.
Common Bear Market Triggers
On the list of potential events to trigger a market cycle, economic growth is often a contributing factor. If the economy does well, financial markets tend to go through an upward spell, potentially culminating in a bull market.
Similarly, suppose economic growth is sluggish or grows negative. In that case, investors will be keen on protecting their portfolio and may sell specific assets. If enough people sell in the same period, a bear market can occur.
Potential signs of a weakening or negative economic growth include:
- Higher unemployment
- Low disposable income
- Decreasing productivity and export of goods
- Government intervention in the economy
One has to keep in mind government intervention can come in many different forms and shapes. The prominent examples include:
- Increasing taxes.
- Cutting down on savings accounts’ interest rates.
- Offering stimulus packages to boost the economy.
During the COVID-19 pandemic, all governments have issued stimulus packages of some sort, which will often have a long-term negative impact on a country’s economy.
The Importance Of Investor Confidence
Any financial market is only as strong as the confidence of the people investing in it. If investors expect a negative turn of events, they will resort to taking action quickly. In most cases, investors may trigger a small bear market before any bad news takes place.
An excellent example of dropping investor confidence is when publicly traded companies – Apple, Tesla, Facebook, and others – report their quarterly earnings. If investors expect weak numbers, they are likely to begin selling stocks ahead of the earnings call.
The confidence of investors can be rocked quite easily. Most of these investors actively seek out news that may affect their portfolio in any way. Even a small rumor can be enough to trigger some people to liquidate their holdings as quickly as possible.
Some investors and traders maintain the “buy the rumor, sell the news” approach as an active trading strategy. Your mileage may vary when exploring this option.
The Bear Market Is A Trend
As we mentioned in a previous article, financial markets go through trends regularly. These trends can come in three forms: a bull market, a bear market, and sideways trading.
It is not uncommon to see a bull market turn into a bearish trend followed by months of sideways trading before the cycle begins anew. Such trends apply as much to cryptocurrencies as they do to any other market.
Trying to oppose a bear market is virtually impossible. While the negative market pressure will eventually end, there is no point in catching a falling knife. Going with the overall market trend is often better, even if that means leveraging derivatives instead of sticking to spot trading.
What Happens In A Bear Market?
It is crucial to distinguish between a bear market cycle and a price correction. The latter can occur during any bull trend or period of sideways trading. A price correction will often not last long, although it can trigger a significant price change quickly.
A bear market, on the other hand, is a lot more pervasive. When this trend kicks in, inexperienced traders are the ones who risk losing the most money. Additionally, it is a strong ‘warning sign” for those entering financial markets without the required knowledge. If one of your first trades goes south due to a strong bear market, one may not be inclined to return.
The big difference between a bull market and a bear market is how quickly changes occur. It takes a lot more time for a bull market to push higher values, as there will be crucial resistance points to overcome. In a bear market, however, traders can move the price down very quickly. Support levels are often far more brittle than resistance levels, as they are not “psychological.”
As such, a bearish trend may trigger daily price changes of 10% or more. In a bull market, gaining 10% can take days, if not weeks or months.
The Phases Of A Bear Market
Traders and investors have come up with ways to attempt and predict a bear market before it happens. As such, one can state there are several “phases’ to a bear market. They go as follows:
- High prices and high investor sentiment lead to extensive profit-taking and the upward price trend coming to an end.
- Prices begin to fall quickly, trading intensifies – but buying pressure remains lower than selling pressure. Economic indicators start to shift into negative territory. Capitulation is a matter of time.
- Speculators start to enter the market, raising prices slightly and increasing the overall trading volume. Their impact isn’t felt immediately, but the sell-off starts slowing down.
- Prices continue to decline slowly. Investors are beginning to shore up buy orders at prices they deem worthwhile, creating a price floor. The good news starts coming in, and the price begins to rebound.
As this last phase begins to take shape, the bear market’s outcome will be either sideways trading – to slowly extend the price floor and turn it into a support level – or a complete reversal into a bull market. By using the correct technical analysis indicators, traders can determine which way the market will go next.
An Example of Shifting Trends
Finding an example of a bull market transitioning into a violent bear market is not difficult. In March of 2020, when the coronavirus was deemed a global pandemic, the US stock markets crashed violently for several days. While they managed to recover some losses ever since, it serves as an excellent example of a bearish trend materializing.
What makes this chart remarkable is how there was no sign of breaking the bullish uptrend until a few days before the crash. Financial markets are living and breathing creatures that can shift gears on a dime and trigger an entirely different sentiment.
Another example is the Financial Crisis of 2007-2009. It all started when the S&P 500 hit a high in October 2007, triggering a crash by over 50% in the next 18 months. The crash took place due to the housing mortgage defaults weighing on the US economy. It was a coming together of unfavorable economic events, which kept compounding negative investor sentiment and fueled a global stock market panic.
Making Money In A Bear Market
During a bull market, making money is relatively easy. You buy the asset rising in price and try to sell it at a higher price. It is possible to repeat this circle over and over again, making money every single time. Those are the fun and most straightforward market trends to make good money. However, they still require a viable trading strategy and basic knowledge of market indicators.
It is often best not to directly buy the assets while the price is still going down in a bear market. Instead, one should follow the trend and short that specific market through futures contracts or derivatives. It may even be worthwhile to leverage one’s position, assuming the indicators confirm this bear market may last for a while.
Another option to explore is to perform swing trades. While relatively risky, there will be times when the bearish momentum is broken briefly. Scalping these temporary lows and highs can net decent profit. Still, it requires vast market knowledge and a severe risk appetite. As long as your overall trading follows the current trend, results may prove worthwhile.
For traders who prefer a slightly different option, experimenting with inverse ETFs may be a good option. These indices are created to express bearish sentiment on the assets they track. It is a useful tool to take advantage of a bear market. Traders can often leverage their position to exponentially increase returns.
Experimenting with ETFs – or Exchange-Traded Funds- requires a good understanding of the products, the indices they track, and what each individual asset of that index represents. It is not something for neophyte traders to jump into right away. Still, it remains a viable option after gathering essential market experience.
Beware Of Fake Reversals
During a bear market, one thing to keep in mind is how not every recovery sign will lead to a market trend reversal.
The market may “bounce” and temporarily recover from the onslaught. Entering a long position or adding the asset to your portfolio at this time can prove very risky. A “dead cat bounce” occurs a lot more often than people think. Counter-trend price movements can happen, but they are usually short-lived.
Again, it is often better to follow the bear market instead of trying to scalp potential bounces. Even if you firmly believe in the asset or market in question, it all comes down to making money in the end. One’s personal opinion on the market is of no consequence in this regard.
Even though it may not seem like it, a bear market is an excellent opportunity to make money. However, it requires a very different approach than trading a bull market, which is a lot more straightforward to handle. Entering a bearish trend without market knowledge will eventually cost you money.
That said, with the right trading strategy and sufficient knowledge of markets and derivatives products, a bear market is a golden opportunity waiting to be explored. Short positions and bearish futures contracts exist for this specific reason. Using them to their full potential is often beneficial to traders.
It is crucial to note that bear markets are not always negative. In many cases, they are a logical reaction to external events surrounding companies or assets, including political changes or government decisions. A bear trend can serve as a ‘reset” for a market that has recently seen too much growth too quickly. It will not automatically negate all of these gains but may help create a more stable price floor for the future.