New traders thinking about investing in the stock market or already invested might have heard about the bear markets. In a bear market, the stock price drops. In this blog, we will discuss trading in the bear market.
But before this, we will thoroughly understand the concept of a Bear Market and its types. We will also cover identifying a Bear market and tools that we can use for this purpose.
How the Bear Market Occurs?
A bear market is a phase, ideally lasting for months or years, during which securities or trending prices consistently decline.
The term bear market describes the stock market and specific sectors such as stocks, foreign exchange, or bonds. For example, a bear investor expects prices to fall and, on that basis, sells a borrowed commodity or stock with the expectation of later buying it back at a lower price.
Types of Bear Markets
A bear market is divided into sections with varying retrieval times and outcomes. A few of them are more damaging to a country’s economy in the long run. We will go over the two types of bear markets that investors are familiar with.
Cyclical Bear Market
A cyclical bear market most likely occurs at the end of a business cycle, is short-lived, and arises as a result of regular market volatility and fluctuations in an economy caused by business cycles. They do not occur in an instance but rather over a period of 7-10 years.
Falling prices of stock in this stage change automatically in two or three months. This type of bear market is easy to spot because it occurs on a regular basis these days. Stock prices in the bear markets tend to fall, but they recover quickly compared to the secular bear market.
Secular Bear Market
A phase distinguished by a fall in the stock prices for a prolonged period and remaining for 10 to 20 years. A secular bear market can be defined as a long-term occurrence with uncompromising circumstances regardless of economic downshift and cycles.
Secular bear markets are more damaging to the economy because they last very long, and no one knows when they will end.
There could be a myriad of factors that could cause the bear market. An instantaneous elevation in the Inflation rate, higher rates of unemployment, and an economy entering a recession due to events that cause damage to the economy like Covid-19 or war situations(Russia and Ukraine war) are some of these factors. But there is no clarity on when it might occur as the stock’s price change every day, but these causes can provide us with a viewpoint that it might happen.
How to Identify a Bear Market?
As discussed, a bear market in an economic asset denotes a downward price trend with lower highs and lows, posing a problem for bear market traders.
If stocks consistently rise in a bull market, investors’ lives will be painless, stress-free, and full of happiness. Unfortunately, this isn’t always possible.
With a slowing economy during a bear market, investors usually get scared and start to sell the stocks to avoid losses. But people who have prior knowledge of the Bear market can benefit from this situation. Usually, people wait for the prices to go down for shares they desire and make a profit by purchasing them at the lowest cost.
In a bear market, it is all about the time, so you must be able to identify the time or the closet to make a profit from it. It is hard for the new traders because most of the time, youngsters start trading without any prior knowledge.
There is nothing wrong with it, but this investment strategy is not going to work out in the long run. If you want to make a profit from trading in a bear market, you must read the best investment strategies mentioned below in this article.
Keep note of the following points as this identifies a bear market-
- Stock prices will start to drop, and negative performance will impact investor sentiment.
- Investors will trade current holdings and stop buying additional shares.
- Economy spending decreases, directing to deflation.
- A decline in corporate earnings and an increase in unemployment levels.
Most stock consultants or advisors will always suggest their clients stay fully invested in stocks for a long time (which will keep their fees flowing without interruption) since it is impossible to time the stock market.
They are somewhat correct that it is impossible to pick highs and lows at the right time. But they are inaccurate when they lead you to think that you cannot dodge massive losses or earn some profit by knowing how to determine the indicators of bear markets and acting sensibly on those indicators. It is crucial to consider these points while investing in the stock market.
Investors observe share prices and many indicators that provide objective evidence that the stock market has entered or will enter a bear market trend. These indicators include advance-decline lines, new highs, lows, etc.
A type of trend indicator, simple moving averages, can be used to identify bull and bear market trends. A line on a price chart represents the average price of the assets over a period of time and changes every trading day. It is important to be wary of falling stock prices.
Shifting or moving averages are useful for evaluating trends because they filter out the noise of day-to-day price trends and provide a more objective picture.
How is the bear market different from an economic recession?
Although these two usually go conjointly but are associated with different issues. A bear market describes a decline in the stock market because of negative investor sentiment. On the other hand, a recession is a decline in the gross domestic product for at least two consecutive quarters, resulting in a downshift in economic growth and functions as a measure of a nation’s economic health.
In short, the market may be up even when the economy is moving downward.
The causes of an economic downturn vary and change. One of the primary causes is a business or industry failure, which results in a loss of consumer confidence in investing. Lower confidence generally indicates slower retail sales, and companies hire fewer people, creating a negative feedback loop as firms cut back in response to lower demand, reinforcing customer discouragement.
A bear market can also cause an economic recession by depleting a company’s capital. Investor confidence and stock prices may suffer as a result of a recession. A bear market can also start a recession by putting strain on businesses that rely on investor funds. It’s a classic case of cause and effect.
Some of the other causes of an economic recession may include credit crunches that refer to a reduction in lending activity by financial institutions(Banks, Cooperative societies, etc.) due to a sudden deficiency of funds, high-interest rates, and decreasing housing sales and costs.
How to trade in a bear market?
As we all know, a bear market occurs when the prices of stocks fall faster than expected, and pessimism grows as investors anticipate losses in a bear market and selling continues.
When stocks start declining, it is difficult to understand and predict when they will reach their bottom. If you wait too long, stock prices will rise again, and you will miss an opportunity to buy them on a dip, resulting in another loss.
And if you invest in them too quickly, they may decline further, and you might lose again. Thus, it is tough to pinpoint the most appropriate timing in a Bear market. However, it is possible to become profitable in a bear market if you know what you do.
Here are some factors to consider while trading in a bear market:
Invest small but regularly
When price movements start to take a significant fall or a downfall, do not start purchasing the stocks instantly. Instead, wait for a while. When you think the stakes are holding up, invest slowly and smartly.
The best way to invest is to not go all-in at once because the stock prices may further decline. Initially, this may look like you are losing money in this. But it can turn out to be profitable.
Invest in the sectors that perform well during recessions
A bear market can start a recession, and a recession can result in a Bear market. Once you start investing, try to find out the sectors that perform well in recession times.
Guidance from the financial advisors
It is always advisable for new traders to seek financial advice because they will recommend the best stocks to invest in when the market is in a downtrend. Do not make a hasty decision because a bad decision will result in loss.
Research before trading in bear markets
The best way to become good at trading in a bear market is by doing a lot of research. You can use the data from the past to outline which stocks made a profit. From this, you can track the performance of the different stocks and decide which one to invest in.
In present times, numerous financial platforms display or publish different field performances at different duration. Utilize them to identify which sectors are presently surpassing others. Start to invest some of your money into those sectors, and once it performs well, it can be profitable in the long run.
Best trading strategies to trade in a bear market
Trading without strategies can result in a significant loss. It is critical to complete your homework before investing your money in anything. Whether it’s exams, real-life problems, or trading, you must outline your plans, do your investment research, obtain information, and study strategies that will eventually lead to success.
When unfavorable performance is associated with high investor indecision, the best strategies can guide traders through trading. Those with the best plan in their pockets make the most money during a bear market. We’ve compiled a list of popular trading strategies for you to consider:
Shorting stock or short selling can be a way to make a profit when the trend is going down. In a short sell practice, traders borrow stocks they don’t own and sell them while the cost is high and buy back once the prices decline. Investors follow bear market directional momentum, but timing matters the most. If your prediction works, you make it again. But prices can shift either way. If it moves against your prediction, you will also face a loss.
Using a stop-loss order
A stop-loss is a tool to limit an investor’s loss on a security position. Once the stocks reach a less favorable price, a stop-loss order will automatically instruct traders or investors to exit a position.
Accordingly, in the case of short-selling, a stop-loss order would be at a price, which is higher than opened position, and vice versa in the case of the long run. In case the market moves against you, this risk management strategy will help you reduce losses.
Making profits at periodic intervals
The possible price movement in a bear market is falling. It could be a chance for the smart traders to lock in profits. Due to the uncertainty of the market, it’s crucial to recognize that prices can shift up and down even in bear markets.
Expand your portfolio
To bypass all the damage that occurs during a bear market is very difficult, but if you have a diversified portfolio, you can avoid the worst bearish trading motion. Diversification will ensure you have at least something in your portfolio when things get bad in the market.
Keep a repository of your trades
When the market is experiencing a crash and people are terrified all around you, it is best not to do stock analysis. It would be a good practice to keep a record of stocks you are interested in purchasing under the right conditions, and it would be a great way to avoid being overwhelmed with information during a bear market.
This is due to the fact that market conditions will change on a regular basis. And it will make you reconsider purchasing the stocks. A watchlist will assist you in focusing your attention on a few useful and profitable stocks. You never know when the fall will come to an end.
The above-mentioned bear market trading strategies are a few of the best ones employed by professional investors while investing in a bear market. Bear markets are very tough to deal with because there is no certainty as the downtrend can change anytime and shift upwards.
The Key Takeaways
We hope this article’s information would have helped you understand what a bear market is, how it starts, the different types of bear markets, their duration, and how long they can last. You may have realized that there is no guarantee of what will happen because commodity prices can change at any time.
We also discussed economic recessions and how a bear market can lead to a recession or vice versa. Investing in a bear market can be high risk because you can lose everything if you don’t take precautions.