Financial markets are cyclical, so periodically there is a so-called bearish phenomenon in which most assets lose up to 20% or more in a short period of time. Some people lose money on this, but experienced investors and traders see it as a great opportunity to make money in the long run.
We have prepared for you a detailed description of the bear market with a guide on what trading strategies you can use to profit.
What is a bear market?
A bear market is when a market experiences prolonged price declines. It typically describes a condition in which securities prices fall 20% or more from recent highs amid widespread pessimism and negative investor sentiment.
The bear market phenomenon is thought to get its name from the way in which a bear attacks its prey — swiping its paws downward. This is why markets with falling stock prices are called bear markets. Just like the bear market, the bull market may be named after the way in which the bull attacks by thrusting its horns up into the air.
A bear market begins when most of the most important and liquid financial assets lose value. Wall Street most often evaluates the onset of a bear market by the key indices: the Dow Jones, S&P 500 and Nasdaq. After all, they reflect the dynamics of price changes of the largest companies in the world by capitalization. Accordingly, if indexes are losing positions in parallel for a long time, the market is dominated by bears.
In such a situation, it is important for investors and traders to stay calm and follow proven trading recommendations and strategies, which we will describe in this article.
Understanding bear markets
The causes of a bear market typically vary, but in general, a weak or slowing or sluggish economy, bursting market bubbles, pandemics, wars, geopolitical crises, and drastic paradigm shifts in the economy such as shifting to an online economy, are all factors that might cause a bear market. The signs of a weak or slowing economy are typically low employment, low disposable income, weak productivity, and a drop in business profits. In addition, any intervention by the government in the economy can also trigger a bear market.
For example, changes in the tax rate or in the federal funds rate can lead to a bear market. Similarly, a drop in investor confidence may also signal the onset of a bear market. When investors believe something is about to happen, they usually prepare to take action — in this case, selling off shares to avoid losses.
On average, bear cycles last about 12-18 months, followed by a bullish rally. This was the case, for example, during the global economic crisis of 2007-2008, as well as during the crisis caused by the COVID-19 pandemic in 2020. Nevertheless, there are also multi-year bear cycles lasting more than 10 years. However, they were last manifested in the last century. The current economy is growing too fast, so the duration of each cycle is shortening.
Potential guide: how to trade in a bear market?
Despite the clear signs of a bear market in 2022, many investors and traders remain optimistic. After all, experienced financial market participants know that this period could be a potentially good opportunity for investing. After all, key financial assets like stocks and bonds decline in value during a downtrend. This allows you to acquire assets at a lower price.
Because the economy is cyclical and is more likely to recover after some time, any investments made during the bearish period may have an increased chance to be profitable. However the risks for losses (due to further asset declines) are always there and the investors should have a solid and efficient risk management plan in place.
Let’s look at a few recommendations for trading in a bear market:
- Diversify your holdings. Speaking of picking up stocks at lower prices, boosting your portfolio’s diversification — so it includes a mix of different assets — is another valuable strategy, bear market or not. During bear markets, all the companies in a given stock index, such as the S&P 500, generally fall — but not necessarily by similar amounts. That’s why a well-diversified portfolio is key. If you’re invested in a mix of relative winners and losers, it helps to minimize your portfolio’s overall losses.
- Invest in sectors that perform well in recessions. If you want to add some stabilizing assets to your portfolio, look to the sectors that tend to perform well during market downturns. Things such as consumer staples and utilities usually weather bear markets better than others.
- Focus on the long-term. Bear markets test the resolve of all investors. While these periods are difficult to endure, history shows you probably won’t have to wait too long for the market to recover. And if you’re investing for a long-term goal — such as retirement — the bear markets you’ll endure will be overshadowed by bull markets.
- Make dollar-cost averaging your friend. A prudent approach is to regularly add money to the market with a strategy known as dollar-cost averaging. Dollar-cost averaging is when you continually invest money over time and in roughly equal amounts. This helps smooth out your purchase price over time, ensuring you don’t pour all your money into a stock at its high (while still taking advantage of market dips).
You can take advantage of these tips to potentially enhance your trading strategy. The main thing is not to miss the most opportune moment to buy. After all, the bear market is divided into 3-4 stages. At the final stage, the value of stocks and other assets begins to rise again due to the fact that ‘whales’ (i.e. large investors) increase purchases against the background of low prices, increasing demand for the most liquid low-cost financial instruments.
Conclusion
The bear cycle does not mean the collapse of the economy or the destruction of the usual market laws. It is just one of the economic stages, which is necessary, among other things, as one of the harbingers of subsequent growth. Therefore, many experienced investors and traders do not lose opportunities by using basic recommendations and strategies to add to their asset portfolio at a lower price.
You can use the enhanced and well-built NAGA’s trading tools as well as the extensive functionality of the trading platform to increase your chances for profitable investments. Even in bear market conditions, many opportunities for trading can be found, given that a solid and efficient risk management plan is in place for each investor’s trading strategy.
Summary
- Bear markets occur when prices in a market decline by more than 20%
- Focusing on the long-term and diversification are some of the ways in which investors can make money during a bear market as prices fall
- Bear markets are cyclical and usually last from 12 to 18 months (but there have been cases where they lasted more than 10 years)
- Investors and traders use bear markets as an opportunity to invest in assets at a lower price
