What is a bear market? Examples and trading strategies

07/12/2022, 04:37 PM

What is a bear market? Examples and trading strategies

A bear market can be defined as a long-lasting downward trend in the financial market.

If you are a new investor on the block, you must have heard a phrase like: "We are in a bear market now”.

Phrases like this one is often used to describe the negative trend on the market.

Just like every other market, financial markets have positive and negative trends. A time frame with positive market trends (stock prices are high and the sentiment is very positive) is known as a bull market. The opposite of a bull market is a bear market.

What is the key element that dictates the market trend and thus the cryptocurrency, stock or bond prices? Basically, the future expectations of cryptocurrency prices or company profits will reflect the prices on the market. If the expectations and market conditions are positive, the prices will move up. On contrary, if predictions are negative, the prices will go down.

If the first negative news or negative price indicators appear, investors will rush to sell their stock or cryptocurrencies to protect their gains. Massive stock or crypto sale (also known as dumping) in a short amount of time will crush the prices. If the selling trend continues, the negative trend will last longer.

What is a bear market?

Economic experts and analysts define a bear market as a long-lasting period in which stock, bond, or cryptocurrency prices decline.

Many of these experts believe that the bear market starts once the prices fall by 20% from their all-time high.

It happens once certain negative news or event undermines investors' confidence. At the first sight of negative trends, investors start to sell their stocks or cryptocurrencies (in order to protect their gains or to reduce the loss).

The more investors sell their assets, the prices will drop further. This action can easily become a domino effect, which could result in a longer bear market.

The illustration of a woman on a laptop worrying over a bear market.

What is the cause of the bear market?

There can be various events that can cause a market price decline. Slower economic growth, unstable geopolitical situations, wars, pandemics, etc. can trigger a shift in the market.

These events are a signal to investors that the investment climate will not be favorable. As the result, they will sell their shares or cryptocurrencies.

How long do bear markets last?

According to research, bear markets last an average of 9-12 months. The shortest bear market in history was in 2020 during the pandemic and lasted 33 days, after which the financial market recovered.

In the 2000s, the bear market lasted for 929 days (2.5 years) and occurred as a result of an Internet stock bubble burst.

4 key phases of the bear market

Phase 1 - Pessimistic investment climate

The investors are not positive about the future market direction. They decide to sell their stocks or cryptocurrencies or stop buying more. Less buying actions lead to an increased supply of stocks and cryptocurrencies. If there are not enough buyers, the prices will start to decline.

Phase 2 - The decline of stocks, bonds, and cryptocurrencies

Since there is only a small number of potential buyers, company stocks, or cryptocurrency value declines. The market decline could affect the consumers. If the negative climate spreads, the consumers will have low buying power. Consequently, the companies will lose money, and this will lead to a hiring freeze and lower production.

Phase 3 - Negative trend

By this point, the market stopped growing, which confirms the negative sentiment. In order to prevent further losses, investors will turn to more “stable” types of assets (like gold or stablecoins).

Phase 4 - Domino effect and capitulation

If there is not any positive news that could signal the end of a negative trend, the pressure to sell the stock or cryptocurrency will continue to dip. This will result in a domino effect that will crush the prices further until the investors eventually surrender.

After the prices hit the bottom, investors will slowly return to the market and start buying at a steady pace. If the buying trend is followed by good news and predictions, a bear market could easily shift to a bull market.

Is a bear market the same as recession?

Bear markets shouldn’t be confused with recession. Although there might be a chance that a bear market is a prelude to a recession, that correlation is not confirmed. Here is why. According to previous records, since World War 2 there have been 12 bear markets. Only three out of those 12 resulted in a recession.

A recession is defined as a decline in Gross Domestic Product (GDP), while a bear market describes a period in the financial market that may be a result of a negative trend.

Is the bear market a good time to invest?

Buying low and selling high is the goal of every investment. This is why a bear market may seem like a perfect time to buy stock or cryptocurrencies at a lower price. But it’s not that simple.

First of all, nobody can predict how much time will bear market last, since they move in cycles. Let’s say you bought the dip, but what if the bear market lasts 12 months after your initial purchase?

Investing in a bear market depends on your risk tolerance knowledge, patience, and many other factors. This is why you need a good strategy if you are considering investing during a bear market.

The illustration shows a girl on a skateboard moving up the chart.

5 smart strategies for investing in a bear market

When the bear market cycle starts investors usually take a defensive position. That means that they are selling their assets in order to limit the losses. Selling stock, cryptocurrency or other types of assets only pushes the prices down even further.

Although it may be hard to get returns on investments, bear markets can be a time for regrouping and making proactive moves that be useful in the long term. Here are 5 strategies that could help you navigate through a bear market.

1. Avoid panic sell

If you are new to investing, one of the first things you should know is to keep emotions out of making important investing decisions. Every time investors hear the term bear market a panic starts out.

As a consequence, many investors sell immediately and end up losing money. Remember that bear and bull markets are cycles. Once they end the markets will recover and grow. If you didn’t react on time to use your gains, don’t sell immediately.

News about a bad situation in the market could turn out to be just a small bump on the road. That is why you should be patient and make observations of the market movements to figure out the best timing to enter the market again.

2. Dollar cost averaging strategy

When prices drop during a bear market many investors are trying to chase the price bottom. there are trying to catch the best possible price for entry, hoping that once the prices go up, they can make a decent profit.

But this is a very risky decision since no one ones when the bottom line will hit.

Instead of chasing the bottom and putting large amounts of money on risky decisions, you should try the dollar-cost averaging strategy.

This means you decide to put away a certain amount of money you can afford to lose over a certain interval (for example weekly, monthly, quarterly).

With that amount, you purchase a stock or cryptocurrency regardless of the price. Here is an example of how the dollar-cost average method works.

Let’s say you want to invest 10,000€ in a cryptocurrency priced at 20€. At that entry price, you will have 500 tokens. Now, let’s use the dollar-cost averaging method. You split 10 000€ over 10-month period (1000€ per month).

During 10-month period, the cryptocurrency can go from 25€, 18€, 10€, etc.

This means that during that 10-month period you can accumulate more tokens comparing to the situation when you invest 10 000€ at once.

If the token price rises after the bull market ends you could earn more profit.

3. Move to more stable assets

If you are a long-term holder, one of the best things you can do is to go for a more “stable” type of asset. Stock investors usually choose investment-grade bonds or consumer staples.

Cryptocurrency investors are often opting in for stablecoins like Tether or USD Coin. Stablecoin is the asset that pegs its value to fiat currencies like the dollar in a ratio of 1:1 (1 dollar=1Tether).

Although this is not an entirely risk-free asset it is a great tool to protect your gains until the market fully recovers.

4. Diversify your portfolio

Putting all eggs in one basket is always a huge risk, not only in a bear market. This is why you should consider finding new opportunities to lower the potential risk to your portfolio.

Focusing on one industry sector or company might sound safe, but in the long term, it can be damaging to your capital. The value of a company or sector often changes over time. Some companies may also cease to exist in the future.

Let’s say you are the investor focused on real estate. To diversify your portfolio, you should consider adding other classes of assets like cryptocurrencies, gold, cash, etc. If a recession comes and real estate prices plummet, you will have other assets that might protect your portfolio value.

5. Explore different cryptocurrency options

Many cryptocurrency investors are not aware that their holdings do nothing. Investors that decide to hold their cryptocurrencies during the bear market should consider staking.

Staking refers to the practice of locking away the coins on a proof-of-stake blockchain for a period of time (to help validate the block of transactions) and receiving a reward for it.

The idea is to use the crypto you already have to earn passive income. It is worth noting that there is the possibility that the money you make from staking will be less than the amount you could make from selling coins. Of course, this is if you are looking in the short term. But if you decide to wait for the market to recover you can make a solid profit.

Are we in a bear market right now?

According to the latest Wall Street reports, we are in the bear market. Right now, the world economy is facing inflation and higher interest rates, mostly because of the war in Ukraine and setbacks in the Chinese economy, which is why investors are careful with further buying.

As for the cryptocurrency market, the price of Bitcoin fell again below 20,000$. This crypto bear market is different from previous ones since it’s more correlated to traditional markets and geopolitical situations in the world.

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