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Bear Markets: What is the Lifecycle of a Bearish Trend?

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Investor and philanthropist of the mid-20th century Shelby Cullom Davis once said, “You make most of your money in a bear market, you just don’t realize it at the time.” With that said, what exactly is a bear market?

A bear market, or a bearish trend, occurs when a market decreases in value over time and general sentiment becomes pessimistic. Some analysts define a bear market as a 20% or more decline in price over a sustained period of time, usually at least two months. Bearish trends can last anywhere from a few weeks to multiple years.

Although typically used in reference to the stock market, bearish trends can also occur in real estate, commodities or forex trading. Additionally, a bear market can extend from one sector of the economy to others. For example, a bearish trend in oil may extend into the transportation and construction industries.

Qualities of a Bearish Trend

While the characteristics may vary, below are some common attributes of a bear market:

  • 20% decline in price from a previous high
  • Weak gross domestic product (GDP)
  • Ebbing economic growth
  • High unemployment rate
  • Poor corporate earnings numbers
  • Investor skepticism, negative expectations & general pessimism in the market
  • Increase in short selling

Lifecycle of a Bearish Trend

Following trends is a major tenet of trading securities and recognizing the status of a trend can help traders target entries and exits. Although each bear market is unique in its own right, market analysts have broken down bearish trends into 5 phases:

  1. Denial: This the earliest phase of the bearish trend, when investors refuse to accept the current state of the market. Although prices have begun to drop and technical indicators may trigger bearish signals, some investors will make excuses and try to rationalize the price action as an opportunity to “buy the dip.” Although the writing on the wall is beginning to appear, general market outlook is still positive.
  2. Anger: At this phase in the bear market cycle, investors begin to recognize that the activity points to more than just a pullback. As traders view their losses growing, they may become more frustrated with the current environment. This emotional response acts as a catalyst for the budding bear market and can lead to accelerated selling.
  3. Bargaining: A bear market may experience a slight upwards correction which convinces some traders that the bottom is in and it is time to buy again. The fear of missing out may take over and some traders decide to buy in to avoid missing a rally. In reality, many traders end up adding losing positions to their portfolio during this phase. This is an example of a “head-fake” which may lure in unsuspecting investors. Traders may also sell off their winning positions during this time to offset their losses further fueling the bearish trend.
  4. Depression: As reality sets in, so does the depression of losing investment capital. The depression phase is rather self-explanatory and market sentiment often takes a nosedive.
  5. Acceptance: The final phase of a bearish trend is when investors accept the status of the market. At this stage, unemployment can often rise and more serious economic concerns may surface. Ironically, while many traders accept their losses and take a break from the markets, they can miss out on the opportunity to initiate long positions.

Hindsight is 20/20

Another important aspect of a bear market is that its dates can only be known retrospectively. That is, only when a bear cycle is complete can traders look back and see exactly when it took place.

The chart above tracks E-Mini Dow futures through a bearish trend that occurred between October 2007 and March 2009 as part of the Great Recession. Stemming from the collapse of the real estate market and the subprime mortgage crisis, the Great Recession delivered a devastating blow to US financial markets.

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