What is a Bear Market?

What is a bear market?

A bear market is a period of falling stock prices. Technically, a market is referred to as a bear market after stocks have declined by 20 percent or more.

During a bear market, investor sentiment is extremely low and many investors either sell their investments at marked down prices or avoid making new investments for fear of further decline.

The term “bear market” refers to a bear’s hibernation.

Investors often put their money "into hibernation" when prices fall for fear of losing money if prices continue falling.

However, it is possible to make money in bear markets, too.

Phases of a Bear Market

Bull markets are periods of rising prices.

During bull markets, investors are confident and it is easy to make money. When market prices start to decline, investor confidence suffers.

If the market declines 10 percent, it is referred to as a correction. Corrections are generally short-term periods of market consolidation after a drop.

Not all corrections lead to bear markets.

If the selling continues and markets fall 15 percent, 20 percent, or more, investor behavior can radically shift from caution to panic.

Many market participants who have lost money will aggressively sell to avoid losing more money, and this has the effect of creating volatile swings in the market on a daily basis. These swings can often push prices even lower as sellers overpower buyers.

At some point in a bear market, opportunistic investors buying stocks outweigh the effects of those selling, and prices stabilize and begin to rise.

If a trend of rising prices is reestablished, then the market shifts from bear to bull status. The graphic below illustrates the market stages leading up to a bear market.

Tap or click on the image above to enlarge

Bear Market Investing Strategies

While some investors may choose to hibernate during bear markets, others choose to employ strategies that can limit their losses, or even help them profit.

Here are some common bear market strategies:

  • Buying the dip
  • Investing in low-beta or countercyclical stocks
  • Short selling
  • Hedging

Buying the Dip

First, it’s important to point out that bear markets are a temporary situation until stocks rebound, although they can last for months or even years.

Because they know bear markets eventually end, many long-term investors enjoy buying stocks at depressed prices, which is often referred to as buying the dip.

Buying the dip simply means that you buy after the market or a specific stock has declined, in anticipation of the stock rising at some point in the future. Dip buyers will be rewarded if a bear market quickly reverts to a bull market.

Low-Beta and Countercyclicals

Not all stocks decline during a bear market.

Some stocks, due to their defensive nature, hum along regardless of what happens. Stocks that are less sensitive or immune to market cycles are called low-beta stocks (think hospitals and utility companies).

Beta refers to a stock’s sensitivity to the economic cycle. You can learn more about beta here.

Some stocks even benefit when the economy tumbles; shares in these companies are called countercyclical stocks.

For example, a business that helps deal with employees who are laid off would probably benefit during an economic downturn. This company may see their stock prices appreciate when other stocks are falling.

An investor who owns low-beta or countercyclical stocks can mitigate losses during a bear market because they generally suffer a relatively smaller decline compared to most other stocks. However, low-beta or countercyclical stocks may be unattractive to own during a bull market.

Short Selling In A Bear Market

An investor who engages in short selling can directly benefit if a company’s stock price falls.

Investors may short-sell stocks for a wide variety of reasons. A short seller may believe a company will go out of business or may simply believe the market will fall, taking down most stocks with it.

Therefore, it should be considered a risky strategy, especially for new or inexperienced investors.

Caution: short sellers will lose money if stocks they bet against go up, and because stocks mostly go up over time, it can be hard to make money short selling.

Hedging

Finally, an investor can engage in hedging. Hedging is the process of diversifying your portfolio away from risky assets or putting counter-bets in place that will pay out in a downturn (such as insurance stock).

Someone who hedges wants to reduce their risk exposure. Hedging can be as simple as converting some assets to cash during good times to use to buy assets after prices fall in bad times. Another hedging technique is to bet against the stock market index through short selling or options contracts.

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