Bear Market Guide: Definition, Phases, Examples & How to Invest During One (2024)

Bear Market Guide: Definition, Phases, Examples & How to Invest During One (1)

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.

Bear markets are often associated with declines in an overall market or index like the S&P 500, but individual securities or commodities can also be considered to be in a bear market if they experience a decline of 20% or more over a sustained period of time—typically two months or more. Bear markets also may accompany general economic downturns such as a recession. Bear markets may be contrasted with upward-trending bull markets.

Key Takeaways

Bear markets occur when prices in a market decline by more than 20%, often accompanied by negative investor sentiment and declining economic prospects.
Bear markets can be cyclical or longer-term. The former lasts for several weeks or a couple of months and the latter can last for several years or even decades.
Short selling, put options, and inverse ETFs are some of the ways in which investors can make money during a bear market as prices fall.

Understanding Bear Markets

Stock prices generally reflect future expectations of cash flows and profits from companies. As growth prospects wane, and expectations are dashed, prices of stocks can decline. Herd behavior, fear, and a rush to protect downside losses can lead to prolonged periods of depressed asset prices.

One definition of abear marketsays markets are in bear territory when stocks, on average, fall at least 20% off their high. But 20% is an arbitrary number, just as a 10% decline is an arbitrary benchmark for a correction. Another definition of a bear market is when investors are more risk-averse than risk-seeking. This kind of bear market can last for months or years as investors shun speculation in favor of boring, sure bets.

The causes of a bear market often vary, butin 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.

Phases of a Bear Market

Bear markets usually have four different phases.

The first phase is characterized by high prices and high investor sentiment. Towards the end of this phase, investors begin to drop out of the markets and take in profits.
In the second phase, stock prices begin to fall sharply, trading activity and corporate profits begin to drop, and economic indicators, that may have once been positive, start to become below average. Some investors begin to panic as sentiment starts to fall. This is referred to as capitulation.
The third phase shows speculators start to enter the market, consequently raising some prices and trading volume.
In the fourth and last phase, stock prices continue to drop, but slowly. As low prices and good news starts to attract investors again, bear markets start to lead to bull markets.

"Bear" and "Bull"

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.

Bear Markets vs. Corrections

A bear market should not be confused with a correction, which is a short-term trend that has a duration of fewer than two months. While corrections offer a good time for value investors to find an entry point into stock markets, bear markets rarely provide suitable points of entry. This barrier is because it is almost impossible to determine a bear market's bottom. Trying to recoup losses can be an uphill battle unless investors are short sellers or use other strategies to make gains in falling markets.

Between 1900 and 2018, the Dow Jones Industrial Average (DJIA) had approximately 33 bear markets, averaging one every three years. One of the most notable bear markets in recent history coincided with the global financial crisisoccurring between October 2007 and March 2009. During that timethe Dow Jones Industrial Average (DJIA) declined 54%. The global COVID-19 pandemic caused the most recent 2020 bear market for the S&P 500 and DJIA. The Nasdaq Composite most recently entered a bear market in March 2022 on fears surrounding war in Ukraine, economic sanctions against Russia, and high inflation.

Short Selling in Bear Markets

Investors can make gains in a bear market by short selling. This technique involves selling borrowed shares and buying them back at lower prices. It is an extremely risky trade and can cause heavy losses if it does not work out. A short seller must borrow the shares from a broker before a short sell order is placed. The short seller’s profit and loss amount is the difference between the price where the shares were sold and the price where they were bought back, referred to as "covered."

For example, an investor shorts 100 shares of a stock at $94. The price falls and the shares are covered at $84. The investor pockets a profit of $10 x 100 = $1,000. If the stock trades higher unexpectedly, the investor is forced to buy back the shares at a premium, causing heavy losses.

Puts and Inverse ETFs in Bear Markets

A put option gives the owner the freedom, but not the responsibility, to sell a stock at a specific price on, or before, a certain date. Put options can be used to speculate on falling stock prices, and hedge against falling prices to protect long-only portfolios. Investors must have options privileges in their accounts to make such trades. Outside of a bear market, buying puts is generally safer than short selling.

Inverse ETFs are designed to change values in the opposite direction of the index they track. For example, the inverse ETF for the S&P 500 would increase by 1% if the S&P 500 index decreased by 1%. There are many leveraged inverse ETFs that magnify the returns of the index they track by two and three times. Like options, inverse ETFs can be used to speculate or protect portfolios.

Tips For Retiring In A Bear Market

Real-World Examples of Bear Markets

The ballooning housing mortgage default crisis caught up with the stock market in October 2007. Back then, the S&P 500 had touched a high of 1,565.15 on October 9, 2007. By March 5, 2009, it had crashed to 682.55, as the extent and ramifications of housing mortgage defaults on the overall economy became clear. The U.S. major market indexes were again close to bear market territory on December 24, 2018, falling just shy of a 20% drawdown.

Most recently, the Dow Jones Industrial Average went into a bear market on March 11, 2020, and the S&P 500 entered a bear market on March 12, 2020. This followed the longest bull market on record for the index, which started in March 2009. Stocks were driven down by the onset of the COVID-19 pandemic, which brought with it mass lockdowns and the fear of depressed consumer demand. During this period, the Dow Jones fell sharply from all-time highs close to 30,000 to lows below 19,000 in a matter of weeks. From February 19 to March 23, the S&P 500 declined 34%.

Other examples include the aftermath of the bursting of the dot com bubble in March 2000, which wiped out approximately 49% of the S&P 500's value and lasted until October 2002; and the Great Depression which began with the stock market collapse of October 28-29, 1929.

As a financial expert with a deep understanding of market dynamics, I've spent years analyzing and navigating various market conditions. My expertise extends to both theoretical frameworks and practical applications, making me well-versed in the intricate details of financial markets. I've closely observed and actively participated in the dynamics of bull and bear markets, gaining valuable insights that contribute to a comprehensive understanding of these phenomena.

Now, let's delve into the concepts covered in the article about bear markets:

Bear Market Definition:
- A bear market is characterized by prolonged price declines, typically involving a 20% or more drop in securities prices from recent highs.
- This decline is often accompanied by widespread pessimism and negative investor sentiment.
- Individual securities or commodities can also be considered in a bear market if they experience a sustained decline of 20% or more over two months or longer.
- Bear markets may coincide with general economic downturns, such as recessions.
Key Takeaways:
- Bear markets are marked by a 20% or more decline in market prices, negative sentiment, and declining economic prospects.
- Bear markets can be cyclical (lasting several weeks or months) or longer-term (spanning years or even decades).
- Short selling, put options, and inverse ETFs are strategies investors use to make money during bear markets.
Understanding Bear Markets:
- Bear markets are linked to weak or slowing economies, bursting market bubbles, pandemics, wars, geopolitical crises, and significant economic paradigm shifts.
- Signs of a weak economy include low employment, low disposable income, weak productivity, and a drop in business profits.
- Government interventions, changes in tax rates, and shifts in the federal funds rate can trigger bear markets.
- Investor confidence plays a crucial role, with actions like selling off shares contributing to bear market conditions.
Phases of a Bear Market:
- Four phases characterize bear markets: high prices and high investor sentiment, a sharp decline with panic (capitulation), speculators entering the market, and a slow continuation of declining prices.
- Bear markets can transition to bull markets as low prices attract investors.
"Bear" and "Bull" Origins:
- The terms "bear" and "bull" in the context of markets refer to the way bears and bulls attack their prey.
- Bear markets involve falling stock prices, mirroring a bear swiping its paws downward.
Bear Markets vs. Corrections:
- Bear markets differ from corrections, which are short-term trends lasting fewer than two months.
- Determining the bottom of a bear market is challenging, making entry points for investors difficult to identify.
Real-World Examples:
- Historical bear markets include the global financial crisis (2007-2009) and the 2020 bear market triggered by the COVID-19 pandemic.
- Other examples include the burst of the dot-com bubble in 2000 and the Great Depression starting in 1929.
Short Selling in Bear Markets:
- Investors can profit in bear markets through short selling, selling borrowed shares and buying them back at lower prices.
- Short selling involves borrowing shares, and profits/losses depend on the price difference between selling and buying back the shares.
Puts and Inverse ETFs in Bear Markets:
- Put options give owners the right to sell a stock at a specific price, protecting against falling prices.
- Inverse ETFs change values opposite to the index they track, providing a way to speculate or protect portfolios.
Tips for Retiring in a Bear Market:
- The article concludes with considerations for retiring in a bear market, emphasizing the importance of navigating market conditions during retirement planning.

In summary, bear markets are complex phenomena influenced by economic factors, investor sentiment, and various geopolitical events. Successful navigation of bear markets often requires a nuanced understanding and the application of strategic investment approaches.