A bull thrusts its horns up into the air, while a bear swipes its paws downward. These actions are metaphors for the movement of a market. If the trend is up, it’s a bull market. If the trend is down, it’s a bear market. Likewise, bear markets usually set in before economic contraction takes hold. A bear market can be an opportunity to buy more stocks at cheaper prices. Invest in stocks that have value and that also pay dividends; since dividends account for a big part of gains from equities, owning them makes the bear markets shorter and less painful to weather.
It is common to come across foreign jargon in the world of investing and to be able to manage your way around a stock market it is essential to know what those terms mean. Here, we simplify the difference between a bear market and a bull market:
What is a bear market?
The bear market has unfavourable conditions. Mostly the market falls below 20% than its previous peak. This is the time when the trend falls down, and so does the market. There is a constant fall in the share prices. As there will be no profits in the company, this will lead to the retrenchment of the employees, which eventually leads to unemployment. There is very little purchasing power among individuals in this period. Mostly in a bear market, people tend to sell. The demand in this period is lower than usual. A sharp decrease in the price causes recession. Also, it is a great opportunity to buy the stocks that are on sale, as it is a risk which can be carried on for a longer time.
What is a bull market?
A market which has favourable conditions is a bull market. The system of the country’s economy is sound and bouncing above 20% than its previous downtrend—the activity of buying the stock and selling at the highest peak, which earns higher profits. The market is greatly affected by the investor’s attitude and investment decision. The scenario in the bull market is where the prices are elevated. At this particular time, share prices are particularly high.
In this period of the bull market, employment opportunities tend to increase. This is a time when investors are confident about their money invested as the span of bull market is quite long. But this excessive price rise can lead to inflation due to constant demand and supply. When it shows the highest peak, gradually it could be last, and slowly it could lead to recession.
Bear v/s Bull
Investors behave with different attitudes and psychology with changes coming to the stock market. In a bull market, people or organisations try to obtain maximum profits. They try to buy securities in large quantities but do not sell them. In a bear market, most investors lose confidence and do not buy much. They try to move the money out of the market. This generally leads to a rise in an outflow. In a bull market, consumers have high purchasing power and are willing to spend it. This strengthens the economy. In the case of a bear market, consumers do not spend, and eventually, stock prices fall.
What investors should know?
Investors need to take advantage of the prices when rising in a bull market, i.e., selling the stocks when they are at their peak. In a bear market, losses are bound to happen, so one should cautiously invest. Both markets have a huge influence on investments. One needs to take time and understand the market well before investing. In the long run, positive returns are guaranteed.
Selling Out
One of the safest strategies, and the most extreme, is to sell all of your investments and either hold cash or invest the proceeds into much more stable financial instruments, such as short-term government bonds. By doing this, an investor can reduce their exposure to the stock market and minimize the effects of the raging bear. That said, most, if not all investors, have no ability to time the market with accuracy. Selling everything, also known as capitulation, can cause an investor to miss the rebound and lose out on the upside.
For those who want to profit from a falling market, short positions can be taken in several ways, including short selling, buying shares of an inverse ETF, or buying speculative put options, all of which will increase in value as the market declines. Note that each of these short strategies also comes with its own set of unique risks and limitations.
Playing Defense
For investors looking to maintain positions in the stock market, a defensive strategy is usually taken. This type of strategy involves investing in larger companies with strong balance sheets and a long operational history: stable, large-cap companies tend to be less affected by an overall downturn in the economy or stock market, making their share prices less susceptible to a larger fall. These so-called defensive stocks also include companies that service the needs of businesses and consumers, such as food purveyors (people still eat even when the economy is in a downturn) or producers of other staples, like toiletries. With strong financial positions, including a large cash position to meet ongoing operational expenses, these companies are more likely to survive downturns. On the other hand, it is the riskier companies, such as small growth companies, that are typically avoided because they are less likely to have the financial security that is required to survive downturns.
Protective Put Options
One big way to play defense is to buy protective put options. Puts are options contracts that give the holder the right, but not the obligation, to sell some security at a predetermined price once or before the contract expires. So, if you hold 100 shares of the SPY S&P 500 ETF from $250, you can buy the $210 strike puts that expire in six months, for which you will have to pay the option’s premium (option price). In this case, if the SPY falls to $200, you retain the right to sell shares at $210, which means you’ve essentially locked in $210 as your floor and stemmed any further losses. Even if the price of SPY falls to only $225, the price of those put options may increase in market value since the strike price is now closer to the market price.
Shopping for Bargains
A bear market can be an opportunity to buy more stocks at cheaper prices. The best way to invest can be a strategy called dollar-cost averaging. Here, you invest a small, fixed amount, say $1,000, in the stock market every month regardless of how bleak the headlines are. Invest in stocks that have value and that also pay dividends; since dividends account for a big part of gains from equities, owning them makes the bear markets shorter and less painful to weather.
Diversifying your portfolio to include alternative investments whose performance is non-correlated with (that is, contrary to) stock and bond markets is valuable, too. For instance, when stocks crash, bonds tend to rise as investors seek safer assets (although this is not always the case). These are just two of the more common strategies tailored to a bear market. The most important thing is to understand that a bear market can be a very difficult one for long investors because most stocks fall over the period of a bear market, and most strategies can only limit the amount of downside exposure, not eliminate it.