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Bear Market: Characteristics and Tradings Principles

This overview is dedicated to the bear market, its signs, and some of the popular bear market trading strategies.

What is a bear market?

A bear market is a state of financial markets when asset prices fall sharply and investors become nervous or even panicked. The term usually characterizes the stock market, but can also be used for the forex, commodity, commodity and real estate markets, as well as other sectors of the economy.

The bear market is the direct opposite of the bull market we talked about earlier. During this phase, the price of most stocks falls and follows the stock index. In other words, there is a downtrend: new lows are made regularly, and small local highs are lower than the previous one.

Unlike bull markets, bear markets tend to be short-lived — six months to two years on average. However, they are characterized by increased volatility – prices can fall very quickly. The main reason the market became bearish was the global economic crisis, which caused all major macroeconomic indexes to fall.

Previously, such a period lasted about six months and was triggered by the COVID-19 pandemic. When the crisis ended, a period of active growth (bull market) followed, ending in January 2022. Now we are in another bull market caused by the decline in world economic indices due to the geopolitical situation and the rapid rise in energy prices.

How do you see a bear market?

The beginning of the economic crisis, the rapid rise in prices of energy commodities, the bursting of various bubbles in the stock market – these are the main reasons for the start of the bear phase. At the moment the market is bearish and panicked; Investors try to withdraw money from risky assets to save their capital.

The main signs of a bear market:

Rapid decline in asset prices. Stock indexes and stock prices fall in the stock market. The rough milestone for a bear market will start when the major stock indexes lose 20% of their recent highs.

Negative economic reports. Inflation and unemployment rise, GDP falls, recession threatens (GDP is negative), companies suffer losses.

Pessimism and panic among market participants. Investors try to sell stocks as quickly as possible so they don't fall too far, and put money into cash or bonds, gold, and other protective assets.

How to trade in a bear market

Times like that are undoubtedly scary for investors: no one wants to see the price of their portfolio fall. On the other hand, opportunities arise to make money in the long run while stocks trade at a heavy discount. One can even make a profit from short term sales or just shorting. Let's take a look at some popular bear market trading strategies.

Withdraw and secure cash

Experienced investors can use special protective instruments to protect their portfolios. The idea is to use futures, options or other instruments that make a profit in a falling market. However, hedging can be expensive and requires a high level of financial literacy.

The easiest and most readily available way to protect your capital when asset prices start to drop is to withdraw cash. Cash is the safest place; one can wait for the crisis to end and transfer their capital to one or more safe currencies – US dollars, Swiss francs, or Japanese yen. As soon as the acute phase of the crisis ends and the market bounces back, investors can buy stocks again. Your money is safe while asset prices can be very appetizing.

Short play

In a falling market, a short position can make money selling the asset at a higher price than you bought it. If investors don't have the company stock they need, they can contact a broker and borrow it. They can then be sold, bought after falling at a lower price, and returned to the broker at the profit of the price difference. Stock indices can be sold through futures, options, or CFD contracts.

Short positions are of course short term: the trader sells the asset and keeps the position open for several days or weeks. The goal of such a trade is to catch a bearish wave and take profits at the start of an up move. Such trading requires active trading experience, the ability to use technical analysis tools and indicators, and strict adherence to risk management rules.