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Bear Market Defined – Stock Market “On The Down Low”

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Introduction

 

 

A bear market is a period of time when the broader stock market declines by a significant amount. And while the name sight seem scary, a decline in the broader stock market is a normal part of the investing process. In this lesson, the bear market will be defined in further detail, as we discuss their typical characteristics. We’ll also discuss strategies you might consider to help reduce risk during a bear market.

 

But before we begin, we would like you to read and agree to the Terms & Conditions of this post before you proceed any further.

Disclaimer: Invest In Wall Street is in no way financially or legally responsible for any investing decisions made by any of our readers and are, in turn, acting on their own free will. The information in this article is purely educational and should not be abused or misconstrued in any way, shape, or form.

 

Defining A Bear Market

 

There are generally two types of bear markets, minor connections and full fledged bear markets.

A correction is when the broader stock market, such as the S&P 500 index, declines 10% from its highs. Corrections are common and are typically seen several times per year.

Corrections occur for different reasons such as a negative economic report, or poor earnings guidance issued by a high profile company.

A full fledged bear market is a more significant decline. This type of bear market occurs when the S&P 500 declines 20% or more from its recent highs.

However, bear markets generally occur infrequently.

For instance, from 2000 to 2013, the S&P 500 experienced only two bear markets over the course of 13 years.

A bear market is usually associated with investor pessimism toward the future of the economy, corporate profits, and stock prices in general.

Sometimes a bear market might be a precursor to a recession. A recession is defined by two consecutive quarters of negative gross domestic product (GDP), which is a broad measure of the economy.

 

 

A recession is typically characterized by decreasing consumer spending and increasing unemployment in addition to a declining stock market.

 

 

Some of the worst bear markets in history ultimately lead to a recession. For example, there’s the famous crash of 1929. During this bear market, the broader stock market declined almost 90% over the course of the great depression.

A more recent bear market includes the “dot.com” bubble in 2000. This time, the broader  stock market declined about 47%, leading to a recession.

 

 

Another recent example is the financial crisis of 2008. During this bear market, the broader stock market declined more than 50%, leading to a severe recession.

 

 

But these three examples of bear markets are extreme. In fact, since 1929, the average bear market resulted in a 38% decline in the broader stock market.

Now that’s some of the characteristics. Let’s discuss how investors might confirm a bear market.

Identifying A Bear Market

 

After the broader stock market declines 20% from recent highs, investors can use a drop below yearly or multi-year lows as confirmation.

Another way to help confirm a bear market is to apply the 200-day moving average to a broad market index, such as the S&P 500.

 

 

Some investors view a drop below the 200-day moving average as confirmation.

After confirming a bear market, investors might apply certain strategies to reduce the risk of stocks declining further.

For example, investors might sell a portion of a stock portfolio if the broader market breaks down to yearly or multi-year lows, or if the S&P 500 drops below its 200-day moving average. But whether an investor chooses to sell stocks or not depends on the investor’s time horizon, among other factors.

Keep in mind that since 1929, the broader stock market has needed an average of 5 years to recover from a bear market. So if an investor’s time horizon is less than 5 years, it might be reasonable to consider reducing risk by selling stocks.

Conversely, if an investor’s time horizon is greater than 5 years, it might be reasonable to consider doing nothing but simply hold existing stock positions.

Some investors might even view a bear market as an opportunity to pick up new long-term stock investments at favorable prices.

 

 

Remember, a bear market is a normal part of the investing process. In fact, it typically occurs about once every 5 to 10 years. And so long as investors maintain stock portfolios that align with their time horizons, a bear market is manageable – as it may even lead to potential opportunities.

Quick Recap

In Review…..

Bear Markets

  • There are generally two types of bear markets, minor connections and full fledged bear markets
  • A correction is when the broader stock market, such as the S&P 500 index, declines 10% from its highs. Corrections are common and are typically seen several times per year
  • Corrections occur for different reasons such as a negative economic report, or poor earnings guidance issued by a high profile company
  • A full fledged bear market is a more significant decline. This type of bear market occurs when the S&P 500 declines 20% or more from its recent highs
  • However, bear markets generally occur infrequently
  • A bear market is usually associated with investor pessimism toward the future of the economy, corporate profits, and stock prices in general
  • Sometimes a bear market might be a precursor to a recession. A recession is defined by two consecutive quarters of negative gross domestic product (GDP), which is a broad measure of the economy
  • A recession is typically characterized by decreasing consumer spending and increasing unemployment in addition to a declining stock market
  • But these three examples of bear markets are extreme. In fact, since 1929, the average bear market resulted in a 38% decline in the broader stock market

 

Identifying A Bear Market

  • After the broader stock market declines 20% from recent highs, investors can use a drop below yearly or multi-year lows as confirmation
  • Another way to help confirm a bear market is to apply the 200-day moving average to a broad market index, such as the S&P 500
  • After confirming a bear market, investors might apply certain strategies to reduce the risk of stocks declining further
  • For example, investors might sell a portion of a stock portfolio if the broader market breaks down to yearly or multi-year lows, or if the S&P 500 drops below its 200-day moving average. But whether an investor chooses to sell stocks or not depends on the investor’s time horizon, among other factors
  • Keep in mind that since 1929, the broader stock market has needed an average of 5 years to recover from a bear market. So if an investor’s time horizon is less than 5 years, it might be reasonable to consider reducing risk by selling stocks
  • Conversely, if an investor’s time horizon is greater than 5 years, it might be reasonable to consider doing nothing but simply hold existing stock positions
  • Some investors might even view a bear market as an opportunity to pick up new long-term stock investments at favorable prices
  • Remember, a bear market is a normal part of the investing process. In fact, it typically occurs about once every 5 to 10 years. And so long as investors maintain stock portfolios that align with their time horizons, a bear market is manageable – as it may even lead to potential opportunities

 

 

And this is what bear markets consist of. There are two types of bear markets – that being a minor correction in the stock market (natural, periodic movements) and a full fledged bear market. To be classified as a minor bear market, the broader market must drop by 10% or more. A full fledged market, on the other hand, is classified as a market drop of 20% or more – as these happen during the worst economic conditions, with the potential to negatively impact stock market investors.

However, a market to this extreme is quite uncommon – and if it happens, it will typically take on average 5 years to recover from the economic damage. Note that in a previous lesson, we discussed the boom-bust cycle. To clarify, an economic bust is more so a minor bear market, that has the capacity to become a full fledged bear market. A bust can be one or the other – sometimes even both – the only difference is that a bust is more likely to be accompanied by a boom, as this can occur within a few short years.

Some investors use the bear market to their advantage by investing in other assets – or take protective measures, such a shorting a stock – while some investors will continue to hold onto their stocks knowing that the economy will eventually bounce back.

In the next lesson, we will be discussing in greater detail of the ways to handle the economy when it is in a downward spiral.

I hope you have enjoyed this post and found the information to be quite useful. If you have any questions or concerns, please feel free to leave them down in the comment thread below and make sure to like and share this post.

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