Anyone who trades on financial markets has probably at least come across the terms “bull market” and “bear market”. In this article we focus on the bear market, its features and its significance.
What is a bear market?
If you invest seriously and expect to make a profit on the markets, you should know the terms connected with investing. Two of the most important, perhaps the most important of all, are the bear market and the bull market. Each of them signals something different and also shows itself differently. Neither of them is “good” or “bad” for investors, but each offers different opportunities.
A bear market is a situation in which the market has been falling for a longer period. During this time, asset prices decline over the long term, and investors often become pessimistic, do not hold their positions and sell assets because they are afraid of losses. There is no official definition of a bear market. However, experts generally agree that if the market has fallen by at least 20% from its most recent peak, it is a bear market.
A bear market can be caused by many factors, including an economic recession, war, a pandemic or generally poor company results.
Why is a bear market called a bear market? It is simple: because of its similarity to a bear. As it is a downward trend, and a bear attacks by striking its prey from above with its paws, a falling market looks on a chart like the curve of an attacking bear.
It is not a bear market if assets on the market are rising steadily and then there is a quick, sudden drop. In this case we talk about a correction. A bear market is really a situation in which asset prices fall steadily and over the long term.
Asset prices cannot only fall or only rise forever, which is why bear and bull markets alternate.
The significance of a bear market
A bear market is often marked by pessimism, investors leaving the markets and financial losses for investors. However, it does not have to be like that at all. In fact, it should not be. Financial markets are influenced by a large number of events. We cannot influence these events or how financial markets behave, but we can influence our own behaviour on the markets.
However, no bear market comes out of nowhere. Even though its arrival cannot be predicted completely reliably, there are always some indicators suggesting that it will happen (for example, the major mortgage crisis in 2008, the bursting of the dot-com bubble in 2000 and so on).
In a bear market, asset prices often fall sharply and suddenly. But this does not mean that investors should give up and pull out of the market. On the contrary, falling asset prices encourage buying them at a lower price, with potentially higher returns later once the market recovers. Of course, it is impossible to say for certain which companies will survive such a big economic downturn, but it is worth remembering that nothing lasts forever and the market will also recover one day (think, for example, of the 1929 stock market crash: since then, company share prices have risen many times over).
The pitfalls of a bear market
Of course, it is not only about opportunities. An economic recession may hit one sector harder than another. Companies whose shares are traded on the stock exchange and which operate in only one sector can be riskier than investments with spread risk (for example, ETFs). It can of course also happen that a company does not survive the economic situation and an investor loses money on its shares. Investing, however, comes with risk, and the higher the return an investor expects, the bigger the potential loss can be.
It is important to determine how long the bear market will last and then adjust your investment strategy accordingly. If it is a short-term bear market, it is best to hold on to your existing investments and wait for the market to recover. If it is a longer decline, it may be better to rethink your investment strategy and move part of your money into other assets.
However, it is important not to panic and to remember that markets are volatile. So if we see a drop on one day, it does not mean we should immediately withdraw all our money and close our positions at a loss.
In conclusion, a bear market never comes out of nowhere. It is signalled by various actions and events. Unlike short-term corrections in a bull market, it is a genuinely long-term decline in the markets.
Some investors actually look forward to a bear market with the prospect of buying cheaply (if you buy every month, the price of the asset averages out, so you may buy above the price one month, but the next month you can buy the same asset at a significant discount). At the same time, it is also very important to diversify your portfolio. However, all investing carries risk, and we strongly recommend that inexperienced investors invest with the help of a broker. One of these trusted brokers in the Czech Republic is, for example, XTB. If you would like to compare bull and bear markets, take a look at this article on the bull market.
Bull vs bear market and how they differ
A bull market is the opposite of a bear market. Prices rise over a longer period, company results tend to improve and investors are generally optimistic. The name follows the same logic as the bear. A bull attacks by thrusting its horns upwards, which matches a rising line on a chart.
- Direction of prices. In a bull market, prices trend upwards. In a bear market, they trend downwards.
- Investor mood. Bull markets bring confidence and more buying. Bear markets bring fear and more selling.
- Economic backdrop. Bull markets often come with economic growth. Bear markets often come with slowing growth or a recession, although the two do not always happen together.
- What you can do. In a bull market, your existing investments tend to grow. In a bear market, you can buy assets at lower prices if you have money to invest and a long time horizon.
Bull markets have historically lasted longer than bear markets on major stock indices, but you cannot know in advance how long either phase will last.
What a bear market rally is
A bear market rally is a temporary rise in prices during a wider bear market. Prices may climb quickly for days or weeks, and many investors start to believe the worst is over. Then the decline continues and prices fall to new lows.
These rallies are hard to tell apart from a real recovery while they are happening. That is why buying everything at once because prices have started rising can be risky. A steady approach, where you invest regularly regardless of short-term moves, helps you avoid betting on a turning point that may not be real.
Common mistakes in a bear market
Knowing the bear market definition is one thing. Behaving sensibly when your portfolio is falling is harder. These are the mistakes investors make most often.
- Selling in panic. If you sell after a large fall, you turn a temporary loss on paper into a real one and may miss the recovery.
- Trying to time the bottom. Nobody knows exactly when prices will stop falling. Waiting for the perfect moment often means you never invest at all.
- Investing money you will need soon. Money for a house deposit or bills due next year should not sit in assets that can fall for a long time.
- Stopping regular investments. If you invest a fixed amount each month, a falling market lets you buy more units for the same money.
- Checking your portfolio too often. Watching daily losses increases stress and the urge to act on emotion.
Here is a simple illustration of regular investing. Say you put $500 into a fund every month. When the price is $50, you buy 10 units. If the price drops to $25, the same $500 buys 20 units. Once prices recover, those cheaper units add to your overall return. This does not remove risk, but it reduces the impact of buying everything at a high price.
Frequently asked questions about bear markets
What is a bear market in simple terms?
A bear market is a period when prices on a market fall steadily over a longer time and investors are mostly pessimistic. A common rule of thumb is a fall of at least 20% from the most recent peak. It applies to shares, but the term is also used for other assets.
What is the difference between a bull and a bear market?
In a bull market, prices rise over a longer period and investors feel confident. In a bear market, prices fall over a longer period and fear dominates. Markets move between these two phases over time.
Is a bear market rally the start of a recovery?
Not necessarily. A bear market rally is a short-term rise within a longer decline, after which prices often fall further. You usually only know whether a rise was a real recovery in hindsight.
What does a bear market mean for long-term investors?
For long-term investors, a bear market means temporary losses on paper but also a chance to buy assets at lower prices. If you do not need the money for many years and your portfolio is diversified, staying invested has historically been a reasonable approach. Past results, however, do not guarantee future returns.