What is "Bear Market"?

A bear market is a market in which prices are noticeably declining.

When the market is on a sustained downward trajectory, with little optimism or lots of pessimism from traders to bring about a rally, it is referred to as a bear market.

Causes of a bear market

The usual cause of a bear market is investor fear or uncertainty, but there are many possible causes. While the global COVID-19 pandemic caused the most recent 2020 bear market, other historical causes have included widespread investor speculation, irresponsible lending, oil price movements, over-leveraged investing, and more.

Bear vs. bull

A bull market is essentially the opposite of a bear market. Bull markets occur when there is a sustained rise in stock prices, and they are typically accompanied by elevated consumer confidence, low unemployment, and strong economic growth.

Generally speaking, a bull market is defined as a 20% rise from the lows reached in a bear market, but the definition isn't as strict as that of a bear market. Investors typically mark the start of a bull market at the market bottom of a bear market. For example, the S&P 500 reached the lows of the financial crisis in March 2009, which is considered the start of the bull market that lasted until early 2020.

Bear market rally

One important distinction is the difference between a bull market and a bear market rally. A bull market is a sustained uptrend in stocks — and one that typically results in new all-time highs being reached.

On the other hand, a bear market rally refers to a rise in stock prices after the plunge into a bear market, but one that is just a temporary rise before new lows. To envision this concept, consider how the 2007-2009 bear market unfolded. After reaching new highs in 2007, the stock market collapsed in 2008 after the subprime lending crisis resulted in several major bank failures. After bailouts were announced in late 2008, the market started to rise, but it ultimately reversed course and reached fresh bear market lows in March 2009.

Investing in a bear market

Bear markets can certainly be scary times for investors, and nobody enjoys watching the value of their portfolios go down. On the other hand, these can be opportunities to put money to work for the long run while stocks are trading at a discount.

With that in mind, here are some rules you can use for investing in a bear market the right way:

  • Think long term: One of the worst things you can do in a bear market is made knee-jerk reactions to market movements. The average investor significantly underperforms the overall stock market over the long run, and the primary reason is moving in and out of stock positions too quickly. When stocks plunge and seem as if they'll keep falling forever, it's our instinct to sell "before things get any worse." Then, when bull markets happen, and stocks keep reaching new highs, we put our money in for fear of missing out on gains. It's common knowledge that the main goal of investing is to buy low and sell high, but by reacting emotionally to market swings, you're literally doing the opposite. Invest in stocks you want to own for the long run, and don't sell them simply because their prices went down in a bear market.
  • Focus on quality: When bear markets hit, indeed, companies often go out of business. One of my all-time favorite Warren Buffett quotes is, "When the tide goes out, that's when we find out who has been swimming naked." In other words, when the economy goes bad, companies that are overleveraged or don't have any real competitive advantages tend to get hit the hardest, while high-quality companies tend to outperform. During uncertain times, it's important to focus on companies with rock-solid balance sheets and clear, durable competitive advantages.
  • Don't try to catch the bottom: Trying to time the market is generally a losing battle. One thing to keep in mind during bear markets is that you will not invest at the bottom. Buy stocks because you want to own the business for the long term, even if the share price goes down a little more after you buy.
  • Build positions over time: This goes hand in hand with the previous tip. Instead of trying to time the bottom and throwing all your money in at once, a better strategy during a bear market is to build your stock positions gradually over time, even if you think prices are as low as they're going to get. This way, if you're wrong and the stock continues to fall, you'll be able to take advantage of the new lower prices instead of sitting on the sidelines.