A Bear Market refers to a market where uncertainty and fear overcome positive sentiment which results in continuous selling in the markets over a prolonged period of time.
There is no specific guideline to when we enter a bear market but general consensus is a 20% decline in prices across the broader market over a two month period.
According to experts, 32 bear markets have occurred between 1900 to 2015. This averages to one bear market for every 3.5 years.
The last major bear market occurred during the global financial crisis which happened between late 2007 to early 2009 resulting in the collapse of several financial institutions as well as economies.
How A Bear Market Occurs
Market experts usually measure the occurrence of a bear market when 80% of stock prices decline over a certain period of time. Another measure experts use is market indexes like the Dow Jones Industrial Average.
When it declines below 20%, it indicates the start of a bear market. The most famous bear market to have ever affected the US occurred between 1929 to 1933.
While there are several characteristics that may lead to the occurrence of a bear market, experts point at economic cycles and investor sentiment as the biggest.
Investor confidence is a powerful economic indicator and when investors learn about something for example decline in stock prices or other problems, the main cause of action investors usually take is selling their shares.
This is done with the purpose of avoiding losses as a result of the expected price decrease.
Other characteristics that trigger this phenomenon include a weak economy characterized by low employment rates, low disposable income and reducing profits.
Phases Of A Bear Market
In the first phase, investor confidence and prices are usually still pretty high. Despite this, investors will start to take profits away as they exit the market which can be caused by a number of different economic or political events.
In the second phase, stock prices will begin to decline very quickly. This will trigger a major decline in trading activity as well as corporate earnings and consumer sentiment will begin to diminish quickly as panic selling sets in.
Trading volume and stock prices do increase in phase three but at a slow rate. The reason for this is that speculators are gaining much of their lost confidence. As a result, trading activity is renewed thus jump starting the market.
Despite the slight rising of stock prices in the third phase, they will begin to fall but at a slower rate. This is because investors will react to positive indicators. If the situation continues, the bear market will slowly bottom out and begin to turn around.
It is important to understand that investors can still make lots of gains in a bear market if they turn to short selling, short biased strategies or buy gold which is a safe haven for investors who are worried about the markets.
Bear markets are scary and when they do happen people tend to overreact which leads to panic selling and loss of confidence.
The good news about bear markets is they don’t last forever and the damage can be mitigated if you know how to hedge your portfolio for a down market. You can even make money if you’re positioned correctly.