By: Rupesh Oli
Bear markets are an inevitable part of financial market cycles; a proper understanding of how the bear market functions is vital so that one can achieve long-term success in his/her investment journey. As such a market—a bear market—is inevitable, being an investor, one cannot ignore it too; if done so, one has to pay for it—bearing the losses that s/he never witnessed before.
In layman’s terms, the bear market falls on the contrary side of the bull market where a market rises of at least 20% is considered as the bull market. Conversely, a decline of 20% or more is comprehended as a bear market. The largest short-term rallies occur in the bear market and bring fast-paced declines when compared to the bull market. If we take a look at the housing market crash—the bear market of 10/9/2007-3/9/2009, the S&P 500 index plunged more than 50% from October 2007 to March 2009, and the index experience powerful multi-month rallies of +12%, +18%, and +24%.
These rallies indicate that the bear market, in actuality, delivers more powerful rallies on record than the bull market. The major reason behind it might be the fact that a bear market rally changes the investors’ sentiment most often and that ultimately convinces one that s/he should no longer fear the market, as a result, investors begin injecting money into the market. The rise in stock prices again provides the remaining investors the opportunity who are waiting to sell once the surge occurs. Therefore, the selling takes place resulting in a further decline in the market.
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Intriguingly, as the data depicts, 90% of the fifty largest one-day percentage gains occurred during the bear market, not the bull and 88% of the fifty largest single-day declines occurred during the bear markets since 1980. This is what we call Volatility Clustering as the large single-day advances and the large single-day declines tend to occur merely the gap of days of each other ultimately leading to a bear market as the phenomenon of large daily price reversals is depicted.
We, the majority of the investors, have the common myth that in order to achieve the investment goals we targeted, we must remain invested fully at all times. However, if we ignore the bear market, our overall returns significantly diminish too. Bear markets should be respected, they need not be feared. It, however, requires a different investment approach than the bull market. A proper understanding of how the bear market operates is key to risk management and once adopted apt investment methodology, it not only protects you from erosion of your capital but also books profits as well.
Signs Indicating the End of a Bull Market
As an investor, one needs to weigh the circumstances that could possibly indicate the end of the bull market, and sooner or later the bear market is to enter the financial world. Below is a list of some of the possible indicators.
- Underlying economic conditions of a nation continuously weakening considering both the macro and microeconomic levels.
- Increment in interest rates to a level not witnessed.
- The sharp rise in debt be it the rise in consumer debt, bankruptcy filings, mortgage delinquencies, or consumer debt.
- Surge in the consumers’ interest in gold leading to gold prices surging up.
- Stock market itself indicating the actions such as churning, irregularity in prices along with intense volatility on a day-to-day basis.
Fundamental Analysis and Technical Tools to Identify the Market Downturn
As I have previously mentioned, the majority of the time, fundamental analysis solely is not enough to come to a decision; it can provide many insights which should not be ignored at all too. Analysis based on fundamentals of stocks such as book value, cash flow, earnings, new product launch, future earnings estimates, and so forth is vital to comprehend the contemporary context of any stock however should be aligned with other possible indicators before delving down into decision be it buying or shorting the stocks. The fundamentals of the company might be purposefully hidden or delayed; you cannot rely totally on what you have read over the Internet as knee-jerk reactions to such without proper insight into what could have been missing on the line can incur losses for the investors. So, it is always advisable to acquire information from trusted sources to the extent possible.
Technical approach to confirm what you have abstracted from the fundamental analysis if it falls in line with what the fundamental analysis indicates might be a sign reflecting some havoc to arrive in the near future. For instance, let’s suppose that you have found out the stock is fundamentally degrading over the quarters based on its report and supported further by the technical tools too that it is not acting up to the market as it used to do previously. It further consolidates your findings and analysis, and you can act accordingly as to short, perform averaging over the haul, or exit as to buy back the shares on a further downturn.
Shorting Stocks Amidst the Bear Market
Shorting in a bear market is more likely to book profit during the bear market, that too after the prices have been falling for some days for the confirmation purpose ultimately lessening the risk to an extent. However, shorting late in the game is not as fatal as it seems. It is because even if there occurs another rally sooner in the market, the prices will eventually go lower. You just need to wait and watch as you used to do in the bull market. For instance, when you buy stocks during a bull market, the stocks turn down and eventually travel uphill. A similar case occurs with the bear market as well. However, your success or high-profit margin depends on what level of heat you can withstand. Stop is however necessary and significant too.
Selection of stocks is vital too even in case of shorting. One should prefer to stick to blue chip stocks. It is because they are the ones that are safest and heavily traded. The proper study of charts to select the best stocks for shorting is requisite that one should not overlook.
Staying Long, Sometimes, Can Be Devastating
The very first rule of investing is to protect your capital from erosion and secure the return adjusting the risk following that. If one observes the change of a trend signaling the exhaustion of a bull market, s/he must be willing to sell stocks to protect the investment from erosion. Even living off the capital at the times—such as the bear market—in the long run, seems more reasonable or logical than holding the stocks that decline, that too, when one has instinct validated by strong analysis to support such an instinct.
Hedging is one of the strategies that one can adopt to cut down the losses—that can incur in the coming periods. Suppose you bought the stock with bullish sentiments, and it started falling. Would you have sold it even if the chart showed no signals to sell or there was not any change in the company’s fundamentals? The other alternative to it would be to hedge. You could have done hedging on one hand while holding the stock long—rather than panic selling—on the other hand. When the price would have fallen and reached the level of support and started stabilizing, you could cover your short at a profit and wait for the price to finally get back to the purchase price eventually resulting in the profit. Hence, hedging would have led to you avoiding the losses and ending up with profits at both ends. Unlike a bull market, you hedge against falling shares. You only hedge when the share price is about to fall—or is falling. Once the share prices rise again, you no longer opt to hedge your profits.
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