What Is a Bear Market?

Seasoned investors know how to look at the big picture, riding the highs and lows of the stock market over time. You’ve probably heard about a bull and bear market before, but what is a bear market exactly? Here’s a closer look at how it’s defined as well as the best investment strategies.

What is a bear market?

When security prices trend downward over a sustained length of time, this is defined as a bear market. The general rule is that prices must drop at least 20% for over two months to qualify. Along with reduced stock market prices, investor pessimism and general economic downturn typically come as part of the package.

However, while the bear market terminology is usually in relation to the market as a whole, it can also apply to individual stocks or a specific index. For example, if your company’s stock price has fallen by 20% and stayed there for over two months, we could say that the stock is in a bear market no matter what the rest of the economy is doing.

Bull vs. bear market

How do the animal references of bull and bear markets come into play? It’s said that bull and bear refer to the way that both of these animals attack. While a bear lunges with its paws in a downward motion, a bull thrusts its horns upward. You can use this visual to better understand the differences between bull vs. bear markets.

A bear market is the opposite of a bull market. While bear markets are marked by a sustained fall in stock prices, bull markets go the opposite way. You’ll know it’s a bull market when stock prices rise, consumer confidence grows, and unemployment figures shrink. Bull markets go hand in hand with economic growth.

Bear market vs. stock market correction

When understanding bull and bear markets, it’s also important to distinguish a bear market from a natural correction to the stock market. Stock market corrections are short-term drops in stock prices, making them a good entry point for investors looking for ways to buy low and sell high. While stock market corrections are marked by a slight dip, it’s difficult to determine where the bear market will bottom out.

What causes a bear market?

Bear market causes can vary, and indeed, it’s often a mix of factors that create investor uncertainty:

1. Economic slowdowns

2. Irresponsible lending

3. Natural disasters

4. Falling oil prices

5. Low disposable income

6. Drop in business profits

7. Government interventions

As investor confidence drops for any reason, it means that they’re less likely to buy and more likely to sell shares.

Phases of a bear market

A bear market goes through four phases as part of its natural cycle.

1. Prices are high, as is investor confidence. At the end of this phase, investors start to sell in order to reap the profits of high prices.

2. Stock prices start to fall, causing some investors to panic and increasing sell-offs. At the same time, trading activity stalls and profits drop.

3. Speculators decide to take advantage of low prices and enter the market. This gives trading volume and prices a boost.

4. News of slightly rising prices gives the market an additional lift, with the bear market lifting and giving way to a bull market.

One thing to be aware of as part of this process is the difference between a bear market rally and a bull market. When stock prices slightly rise, this is called a bear market rally. However, the difference is that the rise is only temporary before an additional plummet in pricing. For a rise in prices to qualify as a bull market, the increase must be sustained for at least two months. 

Investing in a bear market

With low prices and economic downturn, is it ever wise to invest during a bear market? The answer is yes, provided you’re aware of the risks and follow a long-term strategy. If you do your research correctly, you can even take advantage of the low prices to pick up high-potential stocks at a discount. A bear market can be a good time to diversify your portfolio by picking out quality stocks. Rather than trying to buy at the very bottom of the curve, instead focus on quality and long-term potential for best results.

Finally, make your purchases over time. Rather than spending all your investment funds at once, chip away at your portfolio bit by bit to take advantage of even lower prices. With these tactics, a bear market doesn’t have to be bad news.

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