Understanding Bull & Bear Markets
Simply put, bull markets are movements in the stock market in which prices are rising and the
consensus is that prices will continue moving upward. During this time, economic production is
high, jobs are plentiful and inflation is low. Bear markets are the opposite--stock prices are falling,
and the view is that they will continue falling. The economy will slow down, coupled with a rise in
unemployment and inflation. In either scenario, people invest as though the trend will continue.
Investors who think and act as though the market will continue to rise are bullish, while those who
think it will keep falling are bearish.
The basics of bull and bear markets will be reviewed in this tutorial. Specifically we will cover the
following:
- What Drives Bull and Bear Markets?
- Predicting Bull and Bear Markets
- Investing During Bull Markets
- Investing During Bear Markets
- What Drives Bull and Bear Markets?
What causes bull and bear markets?
They are partly a result of the supply and demand for
securities. Investor psychology, government involvement in the economy and changes in
economic activity also drive the market up or down. These forces combine to make investors bid
higher or lower prices for stocks.
To qualify as a bull or bear market, a market must have been moving in its current direction (by
about 20% of its value) for a sustained period. Small, short-term movements lasting days do not
qualify; they may only indicate corrections or short-lived movements. Bull and bear markets
signify long movements of significant proportion.
There are several well-known bulls and bears in American history. The longest-lived bull market
in U.S. history is the one that began about 1991 and is still climbing. Other major bulls occurred in
the 1920s, the late 1960s and the mid-1980s. However, they all ended in recessions or market
crashes.
The best-known bear market in the U.S. was, of course, the Great Depression. The Dow Jones
Industrial Average lost roughly 90 percent of its value during the first three years of this period.
There were also numerous others throughout the twentieth century, including those of 1973-74
and 1981-82.
Predicting Bull and Bear Markets
Investors turn to theories and complex calculations to try to figure out in advance when the
market will scream upward or tumble downward. In reality, however, no perfect indicator has
been found.
In their attempts to predict the market, economists use technical analysis. Technical analysis is
the use of market data to analyze individual stocks and the market as a whole. It is based on the
ideas that supply and demand determine stock prices and that prices, in turn, also reflect the
moods of investors. One tool commonly used in technical analysis is the advance-decline line,
which measures the difference between the number of stocks advancing in price and the number
declining in price. Each day a net advance is determined by subtracting total declines from total
advances. This total, when taken over time, comprises the advance-decline line, which analysts
use to forecast market trends.
Generally, the A/D line moves up or down with the Dow. However, economists have noted that
when the line declines while the Dow is moving upward, it indicates that the market is probably
going to change direction and decline as well.
Investing During Bull Markets
A key to successful investing during a bull market is to take advantage of the rising prices. For
most, this means buying securities early, watching them rise in value and then selling them when
they reach a high. However, as simple as it sounds, this practice involves timing the market.
Since no one knows exactly when the market will begin its climb or reach its peak, virtually no
one can time the market perfectly. Investors often attempt to buy securities as they demonstrate a
strong and steady rise and sell them as the market begins a strong move downward.
Portfolios with larger percentages of stocks can work well when the market is moving upward.
Investors who believe in watching the market will buy and sell accordingly to change their
portfolios.
Speculators and risk-takers can fare relatively well in bull markets. They believe they can make
profits from rising prices, so they buy stocks, options, futures and currencies they believe will gain
value. Growth is what most bull investors seek.
The opposite of all this is true when the market moves downward.
Investing During Bear Markets
Successful investing in bear markets can involve many different strategies. Some investors try to
secure their assets in less volatile securities such as fixed-income bonds or money market
securities. Others wait for the downward trend of prices to subside. When it does, they begin
buying. Still others seek to take advantage of the falling prices.
When the market goes down, portfolios with a greater percentage of bonds and cash fare well
because their returns are fixed. Many financial advisors emphasize the value of fixed income and
cash equivalent investments during market downturns.
Another strategy is to simply wait for the downward prices to reverse themselves. Investors who
wish to remain invested in stocks may seek out companies in industries that perform well in both
bull and bear markets -- shares in these companies are called defensive stocks. The food
industry, utilities, debt collection and telecommunications are popular defensive stocks. However,
there is no guarantee that a defensive stock will perform well during any market period.
Finally, some investors attempt to exploit profits from the downward price movements. One
method is to sell at the beginning of a downward turn, when prices are still high. Proponents of
this strategy wait for prices to bottom out before reinvesting in the market. However, as simple as
it sounds, this process involves the nearly impossible task of timing the market. Another, more
complicated way to attempt to profit from falling prices is called selling short.
Concluding Remarks
There are many investment methods that seasoned investment professionals use to take
advantage of opportunities during bull or bear markets. Methods such as dollar-cost averaging,
selling short, and diversification exist. Understanding well-founded strategies will help you to
improve your chances for superior performance in either market environment. However, there is
no surefire way to always succeed. The best weapon you can employ is education. Do your
homework!
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