It is frightening to hear a bear growl. The same holds true in finance, where a bear market means a massive erosion of wealth. The ongoing Covid-19 pandemic led to one of the fastest equity bear markets in history. Benchmark indices across the globe fell by over 20 per cent, which is the standard definition of a bear market.
What Is a Bear Market?
A market which has experienced a prolonged price decline owing to widespread negativity among investors is called a bear market. Also, when a security or a commodity falls over 20 per cent from its recent highs, it is considered to have fallen in bear territory. It has often been observed that a bear market is followed by a recession.
A bear market must not be confused with a correction. Contrary to a bear market, a correction is a short term trend. The decline of a security or an index is termed as a correction when the duration is fewer than two months. While a correction can offer an entry point for investors, a bear market rarely offers one. This is because predicting a bottom in a bear market is extremely dicey.
Characteristics of a bear market
Historically, causes of a bear market have been a slowing economy, low employment, poor productivity in the economy and hence drop in corporate profits. But the 2020 bear market has been caused by the Covid- 19 pandemic and the widespread disruption of economic activity post the lockdown enforced globally. Bear markets typically last for several years or just a few weeks.
Secular & cyclic bear market
A secular bear market may last for over a decade, characterised by below average returns over a long period of time. Such a market is marked by prices resuming to lower levels even after a rally. A cyclical bear market, on the contrary , may last anywhere from a few weeks to several months.
Phases of a Bear Market
Bear market can be characterized by four phases. The first phase is marketed by elevated prices and positive investor sentiments which eventually results in profit taking and hence causing a drop in prices.
In the second phase, prices start to drop sharply as investors sentiments turn poor owing to declining corporate earnings and macroeconomic conditions. Panic selling begins to push the prices lower and lower during this phase.
Some upward movement in prices is witnessed in the third phase when speculators enter the market. In the fourth and the final phase of the bear market, stock prices continue to drop but at a relatively slower rate.
Since the lower prices eventually attract investors, the price starts to gain and eventually the stocks enter a bull market.
Bear Market tips for trading
Bear market is a part of the market cycle and predicting the duration of this cycle is a fool’s errand. Therefore investors and traders can use some of the following strategies to survive a bear market.
- A frequently used strategy is to buy index funds at regular intervals. An index fund is a kind of mutual fund or exchange traded fund (ETF). The portfolio of an index fund is designed to track an index such as S&P 500. These funds follow the index irrespective of the prevailing market conditions. It is a market tip that experts often suggest during a bear market.
- It is considered wise to invest in recession proof sectors. Studies done on the previous bear market suggest that healthcare, personal care, food and logistics among others tend to grow even if the general economic conditions are grim. These products fall under essentials and may be a safe bet in a bear market.
- Keeping an eye out for other asset classes that tend to grow during uncertainties is also a popular strategy. Historically, gold rises during heightened uncertainty. Investors tend to go for a safe-haven asset during such times which pumps up the price of the precious metal.
- Most stocks take a beating during a bear market owing to a general negative sentiment among investors. However, it could turn out to be a great opportunity for value investors. Along with average companies, good companies also tend to take a hit in a bear market, offering a buying opportunity for investors.
Conclusion: Trading during a bear market could be a risky affair. However, if traders study past bear markets, What to do in Bear Market, some market tips have stood the test of time. Looking out for quality stocks, investing in index funds, diversifying your portfolio and buying defensive stocks are among the most trusted strategies.
Stay updated with all the insights.
Navigate news, 1 email day.
Subscribe to Qrius