What Is A Bear Market?
A bear market is a term used to describe a downward trending stock market. The prices of stocks keep falling and investors and traders are pessimistic about the market. These sentiments affect their activities causing stocks to fall even further. When the overall stock market or the leading indices of the stock market fall 20% or more over a period of at least 2 months, the market is generally referred to as a bear market.
This is in contrast to the bull market where prices keep rising and the general sentiment is that of optimism.
Some Terms Associated With The Bear Market:
Secular Bear Market:
This is a bear market which runs for long period of time ranging from 5 years to even 25 years. This is caused due to long periods of decline in the country’s economy or even the world economy. The Great Depression of America in the 1930’s is a classic example of a secular bear market.
Bear Market Rally:
This is a very short phase in the bear market when prices of stocks rise giving a false impression that markets have entered a bull phase. Gullible investors and traders will rush to buy stocks falling into the ‘bear trap’. The rally will soon be over and those who bought shares in the rally will be stuck with no escape route.
In a bull market, there may be sudden declines which will look like the beginning of a bear phase only to bounce back. Such falls of short duration are called Market Corrections.
When the bear market is nearing its end, shrewd investors will start nibbling or buying stocks at rock bottom prices which is known as bottom fishing. In reality however, it is not an easy to predict the market bottom.
When a person who participates in the market has a pessimistic view about prices of stocks or the general market direction, he is called a bear.
What Do Investors And Traders Generally Do In A Bear Market?
- Investors and traders who are sure that the market will remain in a bear phase sell the stocks that they hold, confident that they can buy them later. However, if they do this at the fag end of the bear market, they may never get the opportunity to buy back the shares.
- In a bear market, the bears short sell in the futures market aggressively. This means that they sell the index futures or the individual stock futures only to buy them back (also known as covering) at lower rates profiting from the difference. Short selling can be very risky and should be done only by traders with high risk appetites. The lot size of the futures market is huge and an error in judgment can result in huge losses.
- Investors, who hold large quantities of shares but do not want to sell them in a bear market, instead sell ‘call options’ of individual stocks or the stock indices and benefit from the fall in the market. Selling options are very risky as the extent of loss is unlimited and is usually carried out by large and institutional investors.
- Individual traders who want to make profits in a bear market but have low risk appetite buy ‘put options’. This is because when an option is bought, the loss is limited to the extent of the price paid. The price of put options of an individual stock increases as the share price falls. The put option is then sold resulting in a profit.
A bear market doesn’t always mean losses. Astute investors and traders not only succeed in mitigating their losses but even make profits by executing the right strategies.
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