By: Flabia Maharjan
Market trend in the financial market is defined as the tendency of the market to head towards a particular direction for a notable period. This means security prices will either rise or fall depending upon the market trend. This trend in the financial market is classified into two types, namely, the bull market and the bear market, which are complete opposites. Since market trends have a direct impact on an investor’s portfolio, it is said to influence the decisions of an investor.
Bull Market vs Bear Market
Bull market refers to the market condition when the stock prices are increasing and assumed to increase for a sustained period. There is widespread optimism regarding the stock market performance generally, leading to an increase in demand. A bull market often denotes positive returns over a long period.
On the contrary, a bear market is a market trend where the share prices of a company are in a declining stage and investors are pessimistic as they tend to lose the value of the shares they have/hold. Stock prices are volatile, and investors tend to withdraw their investment from the stock market and hold cash in order to retain the value of their original investment.
The features of the bull and bear markets have been explained under the following headings.
1. Market Forces: Demand and Supply
A bull market is characterized by strong demand for securities. During bull markets, the stock prices are constantly increasing. Higher return on securities influences the traders and investors to buy stocks which will allow them to book profits. There is an increasing number of buyers in the market however, investors who have a position in the respective stocks will not sell them. This means during a bull market, there is a high demand for securities which further accentuates the prices due to low supply in the market.
On the other hand, a bear market is characterized by a strong supply of securities. The prices of the securities are declining which creates panic among the investors and they begin selling their securities. Due to this panic selling, they tend to lose a huge portion of their investment which could have generated positive returns had they waited for the market to recover. Since investors could lose their money if the value of stocks declined further, generally, they choose not to invest which translates to low demand. But the supply is increasing because people believe selling is the best step to take, which further results in stocks losing value.
2. Investor’s Confidence
An investor’s psychology is directly linked with the stock market performance. Bull market denotes an efficient stock market performance with increasing stock prices which raises investors’ confidence, therefore, increasing investment. During the bear market, investor’s confidence hits rock bottom. Investors do not expect much from the stock market except for losses in their investment which results in quick withdrawals.
3. Impact on the Economy
A bull market translates to a robust economy. People believe that their investment is generating favorable returns or has the potential to do so in the future. Therefore, consumer spending is high during this period. To fulfil the increased demand, the rate of employment in the country amplifies, denoting a strong economy. Quite the opposite would happen during a bear market. An economy is weak during this period since investors lose their confidence in the stock market. As investors withdraw their investment, the flow of money to the productive sectors decline due to which companies are obliged to lay off their employees.
“Buy and Hold” strategy is based on Effective Market Hypothesis(EMH) which states that stock prices mirror all the available information and are fairly priced, so there is no need for trade. However, the market is not always efficient. The global financial crisis of 2008 is a great example. According to market strategist, Jeremy Grantham, belief in EMH caused financial leaders to have a chronic underestimation of the dangers of asset bubbles breaking. Therefore, during adverse market conditions, different strategies need to be applied to protect our investment.
Bull Market Strategies:
1. Prioritize Quality
During the initial phase of a bull market, stock prices of good as well as bad companies rise in value. A smart move would be to wait for a while before investing. With time, a bull market rewards selective companies with a higher valuation. One of the basic rules of a bull market is to move towards quality. Thus, this helps you invest in a good company if you are new to investing instead of losing money over companies showing inorganic growth.
2. Have a Financial Plan
Having a financial plan assists you in placing your money in the best risk-adjusted returns. Know how much you would like to allocate in equities, bonds, gold and other liquid assets. When this allocation is distorted, make sure that it comes back to the way it was originally planned. Money arrangement spreads out which guarantees you naturally booked profits at higher valuations and availability of liquidity when cheaper alternatives are present.
3. Growth Investing
This strategy aims for the stocks of fairly young companies which are likely to head towards a positive direction given that the companies have strong fundamentals. Investors can purchase stocks after the careful fundamental analysis of the companies. A bull market enables a good company to grow and makes room for investors to grow along with it.
4. Value Investing
The concept of value investing revolves around purchasing undervalued stocks available at a discounted rate. This strategy works best during the initial to the middle phase of a bull market. This is because companies having good intrinsic value might not have enough demand while the market is recovering, which allows you to purchase them at a discounted rate creating an opportunity to earn profits. Investors must make purchase decisions based on the company’s ‘price to earnings ratio’, ‘price to book value ratio’ and ‘price to sales ratio’ which reflect the strength and weakness of the value investment.
5. Determine an Exit Point
This holds for both your profits and losses. One thing we must remember is that the bull market trend is not going to last forever. This trend lasts for a certain period. Fluctuations in the financial market are common. If you have purchased stock during the bull market, then you can’t expect it to keep on rising perpetually. The probability of loss is there because you don’t know when the market is going to enter the bearish trend. Thus, you must always identify an exit point. This point is where the investor will have booked a profit on his/her investment and therefore sell the securities to avoid being greedy by expecting further returns from the investment.
Similarly, one must not hold losses for too long. During bull markets, investors are intimidated by the increasing stock prices which makes them purchase stocks when it has reached its peak point. The investor suffers from a loss after this point, however, might hold it with an expectation of a price increase. It is wise to set an exit point for losses to ensure that you limit the risk associated with loss in your investment.
You May Also Like:
Bear Market Strategies:
1. Do Not Panic Sell
Stock prices drop during a bearish cycle which significantly impacts an investor’s portfolio. One common mistake investors tend to make is to start panic selling. We might think that it is the best way to save ourselves from probable losses from an economic downturn; however, we are not considering a possible market recovery. Panic selling can result in a loss of stocks of great companies whose prices have declined as they cannot escape the changing market trend.
2. Invest in Money Market Securities
During a bear market, the stock market is volatile therefore, an investor should invest in money market securities that are highly liquid. Such securities include Certificate of deposits (CDs), treasury bills and other instruments of the money market. They have a shorter maturity period and are considered to be safe investments during the period of uncertainty.
3. Buy Good Stocks That Are Underpriced
One good thing about the bear market is that even the stocks of well-performing companies are undervalued, providing a great opportunity for investors to grab these stocks for a relatively lower price. For a bear market to occur, the prices must decline by at least 20 percent. The stock prices of both strong and weak companies decrease, which is extremely attractive to investors. Since good companies become victims of a bearish trend, investors should invest in such companies to earn good returns as the market recovers.
4. Invest in Defensive Stocks
Defensive stocks are rarely impacted by the changing trends of the market. It refers to stocks of companies that produce necessity goods such as shampoo, toothpaste etc. Thus, demand for such goods remains stable during both economic boom and downturn. The stability in demand prevents the stock prices of such industries from dropping even during a bear market. Therefore, it is wise to turn to defensive stocks to ensure safety from losses that might occur due to investment in volatile stocks.
Make sure you diversify your portfolio by investing in stocks, bonds, cash, real estate, and other assets. This spreads your risk and provides you with flexibility during a bear market. It prevents you from being negatively impacted as you avoid putting all your eggs in one basket. A good asset allocation strategy can be made as per an individual’s appetite for risk, investment goals, investment horizon and so on. It ensures that you have assets that are performing well even when the market is going down. An increase in the value of some of your investments will make up for any loss and deliver a greater overall return than the market for your portfolio. Perhaps there’s nothing more vital than diversity to help you hold up to a bad market.
From The Author:
(Liked this article??? If you are also interested in publishing your articles related to business, finance, and economics, then mail us your article at Investopaper@gmail.com.)