Even on a good day, investing in the stock market is risky.
With the recent volatility, 2018 saw the biggest drop since the Great Depression, and now you’re wondering what will happen next. When prices start to fall, it could be a simple correction or the start of a bear market. How do you know if you should be worried?
The short answer: you don’t. Volatility, corrections, and bear markets all start in much the same way. There’s no way to know if a decline will become a bear market until after it happens, but knowing what a bear market is can ease your worry while you wait to see what direction the market will turn.
What is a Bear Market?
Fluctuations are a normal part of investing, but a bear market is a continued drop in prices. When prices fall 20% or more from a recent high and the decline continues for at least two months, you know it’s a bear market. Usually, this accompanies a generally negative outlook and a loss of investor confidence in the market.
Bear markets are considered when there are falling prices in a general market or index, such as the S&P 500. But individual stocks that sustain a decrease of at least 20% are considered to be in a bear market, too.
When you think of a bear market, think of the way a bear attacks its prey. Usually, a bear swipes its paws down. This downward motion mimics the downward drop in stock prices. Hence the term bear market.
Negative economic indicators such as recession, low employment, and rising inflation usually accompany a bear market. Keep in mind that investing is emotional, and it’s easy to lose sight of logic when prices continue to fall.
With lower than average returns, investors can panic and sell their holdings to avoid further loss. But selling isn’t always the best strategy, even in a bear market.
Bear Market Phases
A bear market tends to follow a period of growth in stock prices. As the prices go up, so do investors’ attitudes. In this first phase, investors want to fetch the highest price for their investments and start selling their stock to take in profits.
With stocks being sold, prices begin to drop abruptly, and investors become nervous. Fearing the fall in prices, the mood becomes pessimistic as the market continues to decline.
It’s usually during this second phase that investors start to get anxious. Hoping to avoid losing even more money, they’re more aggressive with selling their investments and stock prices start to plummet.
During the third phase, enough time has passed and the market is in bear market territory. To capitalize on the low prices, speculators jump at the chance to buy when the market is down.
This increase in trading volume slows the falling stock prices and could even cause some to rise in value.
Finally, this reinvestment in the market builds investor confidence and further slows market decline. The growth in market trading paves the way to an increase in stock prices.
As this happens, bear markets frequently lead to bull markets as investor confidence gains strength and prices continue to climb.
Bull vs. Bear Market
Bull markets are essentially the opposite of bear markets. Instead of pessimism and falling rates, bull markets have rising security prices. As with a bear market, it’s almost impossible to predict when market trends change course.
You usually know it’s a bull market when stock prices rise at least 20% after a recent decline of 20% or more. Though bear markets indicate a weak economy, bull markets and their rise in market conditions usually occur when the economy is strong or in sync with a strengthening economic outlook.
Bear Market vs. Market Correction
Though a bear market and market correction are both signified by a drop in market prices, they have different characteristics. With a market correction, the decline generally lasts less than two months and is typically limited to a 10% fall in prices.
Compared to a bear market, which is a drop of 20% or more that lasts two months or longer, market corrections are short-lived. Another marked difference is the negativity associated with bear markets. As prices sharply decline, investors become less optimistic.
A market correction isn’t nearly as discouraging. Instead, investors tend to believe prices rose unnaturally higher than they should have, and a decline in the amount of around 10% is merely a return to true market value.
What to Do in a Bear Market
In a bear market, the declining values can stir up fear and uncertainty. Seeing your portfolio drop isn’t a good feeling, but sometimes the best action to take is none at all. Letting emotions guide your decisions is a recipe for disaster and can lead to losing more money than if you had let it run its course.
Instead of giving in to panic, here’s what you should do in a bear market.
Review Your Portfolio
A bear market is a perfect time to look through your investments. You can review your portfolio on your own or consult with your broker. Keep in mind that your broker doesn’t have a crystal ball and can’t predict the best time to buy or sell.
A company isn’t going to go out of business only because its stock price falls. Even with the declining market, it might make more sense to hold onto stocks from quality companies. If you’re uncomfortable with some of your investments, it’s okay to get rid of them just as long as you’re using logic and not emotions to make the decision.
Keep Your Expectations in Check
Losing money isn’t fun, but it’s often an unavoidable part of investing. Depending on your risk tolerance, your portfolio might be more or less affected by the falling stock prices. For instance, a more aggressive portfolio could see a higher loss during a bear market than more conservative investments.
Markets can swing high and low. Whatever happens, keep your expectations in check. Bear markets won’t last forever, and eventually, prices will go back up.
Investing is full of uncertainty, and the stock market is unpredictable, but timing the market is never a good idea. Even though the goal is to make money, you can’t always expect to buy when the market is low and sell when it’s high.
Keeping close tabs on stock prices can make your emotions run high, and that can lead to irrational decisions. Sometimes it’s best to turn off the news and have patience.
Bear Market FAQs
As you’re working your way through a bear market, you might wonder what to expect going forward. The consensus is to “hang in there” and wait it out. Though you can’t help but wonder what causes a bear market and how long will it last.
What Causes a Bear Market?
As with most things in life, there isn’t one known cause of a bear market. It’s generally linked to a weak or slowing economy that’s suffering from low employment, decreased disposable income, and declining business profits. Though investor sentiment also plays a role in developing a bear market.
For example, when investors fear falling stock prices and sell their investments, it can trigger a steep decline that leads to a bear market. At the same time, if a bear market is already here, the selling of stock can increase the momentum and draw it out further.
How Long Does a Bear Market Last?
Contrary to what you might think when you’re in the middle of a bear market, they don’t last forever. But by definition, the decline will continue at least two months, and often longer than that.
When it comes to how long a bear market will last, there are two classifications: secular and cyclical. Since a cyclical market lasts only a few months, you’ll be better off.
On the other hand, secular bear markets continue much longer, ranging from 5 to 25 years. But historically, the average length of a bear market between 1900 and 2013 was 14 months.
Should You Buy Stocks in a Bear Market?
Falling prices can lead you to believe you should stop buying stock, though this is usually fueled by fear and confusion during periods of decline. Generally, a stock market correction is a more preferable entry point for investors, but there are still plenty of opportunities to buy stocks in a bear market.
It’s better to look at the price drop as more of a sale than a catastrophe. For long-term investors, it’s an excellent chance to buy stocks at a low price. Sure, there’s a risk that the price will drop after you buy it. But if you hold on to it for a while, you could cash in on the low prices.
A Bear Market is No Cause for Panic
The stock market tends to be all over the place. One day it’s up, the next it’s down. But when it keeps going down and enters bear market territory, there is no cause for panic.
The best course of action is to review your portfolio, have realistic expectations, and practice patience. Instead of giving in to constant worry, remind yourself that the falling prices won’t last forever and the market will bounce back eventually.