Let's start with a bear market defintion:
When investment prices drop by 20% or more from their 52 week high.
While there is no firm definition of a bear market, it is commonly defined by a prolonged, significant drop in asset or stock prices. This is generally when prices fall by 20% or more from their most recent high. Both single assets, and entire markets can experience a bearish trend, or bear market. While 20% is widely considered the threshold to be in a bear market, they often fall much further than 20% over the period of the bear market, and it often does not happen all at once. Bear markets are saturated with disillusion, low confidence, and pessimistic attitudes. During a bear market, investors will continue to sell stock, even in the presence of good news and good performance. This pushes prices even lower, and sentiment continues to fall. Bear markets suffer from a negative feedback loop, where sentiment drives prices down, and price in turn, drives sentiment futher downward.
What causes a bear market in the first place?
Traders and investors both observe certain indicators leading up to a downturn in the market. These include, but are not limited to; an unstable or declining economy, low business profitability across sectors, an increase in negative investor sentiment, declining stock values, or globally disruptive events such as the COVID pandemic, or humanitarian crisis in Ukraine. This is not to say that you can predict a bear market with any or all of these factors. However, external events play their part.
How long do they last?
Luckily for us all, there is still hope! On average bear markets are much shorter than bull markets, at an average of 363 days, compared to the 1,742 day average that Bull Markets last for. Not only are they shorter, they have historically been less severe. The Bear market average lossesare 33%, compared to the average bull market gains of 159%.
Since we know that bear markets are not fatal, how can you make the best of it?
- Perspective is key: One of the most important pieces of advice we can give is to stay calm. Even though bear markets are frightening, markets have shown us that time and time again it will bounce back. By refocusing your attention on potential gains rather than potential losses, you can see bear markets as a great time to purchase stocks at lower prices. With perspective and a little bit of clarity, let’s move on to tip #2…
- Dollar-cost averaging: Take an example where the price of a stock in your portfolio drops 50%, from $100 a share to $50 a share. If you have money to invest, it may be tempting to buy when you believe the stock's price has plunged as far as it can. The chances are that you’re wrong. That stock may not have bottomed at $50 a share – It could very easily tumble another 30% or more from its high. This is why trying to pick the bottom, or “time” the market, can be a risky endeavor.
An alternative approach would be to regularly add to the market through a strategy called dollar-cost averaging. Dollar-cost averaging is when you invest money over a longer period of time and in roughly equal amounts. This helps smooth out your purchase price over time, ensuring you don’t pour all your money into a stock at its high, and you continue to benefit from any market dips.
- Diversify your holdings: During bear markets, prices fall. Not everything falls as fast or as far as each other. Every asset you own will behave slightly differently. Some may resist the downtrend early on, and fall significantly later. Others will fall fast and stabilize earlier. This is where we see the true power of a diversified portfolio. If you’re diversified, well done. If you’re not as diversified as you want to be, now is a great time to start, as everything is on sale! You could target yield bearing assets, a strategy that defends against price depreciation.
Diversifying also includes having appropriate cash reserves, and emergency funds. WIth investments, the old adage rings true. You only lose money when you sell. As long as you’re able to weather the storm, you can capitalize on the next bull run. Finally, and maybe most importantly…
- Relax: focus on the long-term: There’s no two ways about it, bear markets suck. They’re frustrating for retail investors, and can be devastating for businesses. Everyone’s resolve is tested. However, despite the difficulties of the bear market, history is on your side. With bear markets on average much shorter than bull markets, you’ll be back to hopefully happy days shortly. If you’re investing for a long-term goal — as most are — bear markets will almost certainly be overshadowed by bull markets.
And this relates to tip #3. Money you may require for short-term goals is ideally not invested in the stock market. A bear market should not drastically effect your day to day life. If it does, it may be a sign that you’re overexposed. Bear markets are tough for everyone, but a great opportunity to take stock, re-evaluate your risk tolerance and investment strategy, and prepare yourself well for the future.
Got any bear market tips? Let us know on Twitter!