What is a bear market?

What is a bear market?

Bear markets are loosely defined as periods when markets experience declines in magnitude of 20% or more. More specifically, bear markets are a period in which a major index like the S&P 500, for example, declines by 20% or more, with this decline sustained for a period over two months or so.

Consequently, many investors become “bearish” – they lose confidence in the market, sell off their securities they do not believe will recover soon, and sit on the sidelines. There have been 25 bear markets since 1929, for an average of one every 3.4 years.

Investor sentiment does play a role in whether a bear market occurs and how long it lasts, and analysts can also use sentiment as an indicator of market phases. Typically, a bear market has four parts.

The first phase is marked by highs – in both prices and investor sentiment – before investors exit the market at a profit. This is followed by drops in prices and trade volumes, followed by investor unease at the declines. Next, speculative traders move in to capitalize on the lows, which boosts the market slightly; this is followed by a shift towards positive market sentiment as low prices entice investors back to the market. 

Some investors look to capitalize on the opportunities bear markets present. Bear market funds, for example, are funds designed to profit when the market or sector they follow declines. Bear market funds exist for most sectors, industries, commodities, markets, or anything else that’s tradeable.

There are also 2X Bear Market Funds, 3X Bear Market Funds, and more, which use marginshort-selling, and derivative instruments to acquire large leveraged positions. The highly leveraged funds are only really meant to be held for a day or so. ETFs with similar structure may be more advantageous to the investor since they can trade intra-day. Investors can also short-sell shares when bearish on a stock in what is called a bear squeeze.

While most investors greatly prefer the bear market’s opposite, the bull market, bear markets can be advantageous to right trader. Understanding the causes and features of bear markets – including chart trends like the Descending Triangle and Rising Wedge – can help investors make rational, unemotional, and ultimately profitable decisions.