We often hear the terms “bull market” and “bear market” used in reference to the stock market. A bull market describes the situation wherein the market experiences a continuous upward trend, whereas a bear market describes the situation wherein the market experiences a continuous downward trend. Despite their close association to the stock market, the terms can be used to explain price trends across asset classes, such as real estate, foreign exchange, cryptocurrency, and more.
Before diving into how to invest in a bear market, we’ll go over phases and key trends during bear markets, and how they often inform investor decisions.
How Do You Correctly Interpret Market Trends?
When markets go through their standard cycle, they typically follow key phases. In the case of a bear market, the typical phases include:
This stage starts with high prices and high investor interest, some of which is driven by fear of missing out, or FOMO. Eventually, investors start selling to realize their returns, leading to an increase in the supply of stocks. When this happens, prices begin to fall.
In this second stage, the market faces a drastic decline in prices. Some investors also resort to panic liquidation during this time.
New Entrants and the Transition to a Bull Market
In the third and fourth phases, the low prices during capitulation start looking attractive to speculators and investors. Prices are still slowly falling at this stage. Nevertheless, as new entrants start buying and trading, volume increases, prices start to rise, and the bear market starts transitioning into a bull market.
While you might think distinguishing between a bear market and bull market is easy given their relatively straightforward definitions, that’s not always the case. Determining the market trend depends on the time frame under consideration. For instance, an investor looking at cryptocurrency market trends from a macro perspective over a long time frame might conclude that it is a bull market since prices have been rising over the last two years. But another investor, judging the market over a shorter time frame, may assert that the market is bearish since prices have been falling over the past couple of months.
Is Investing in a Bear Market the Same as a Bull Market?
Investment strategies and decisions often differ based on an investor’s perspective of the market situation. In a bullish market, the rising prices tend to be interpreted as positive prospects, which translate into optimistic investor sentiment. To maximize profits, professional investors tend to take long positions, specifically with securities or derivatives.
On the contrary, in a bearish market, investors generally hold a pessimistic view of the market and expect prices to continue falling. In this context, these same investors often prefer taking short positions to profit from the declining prices. (A risky tactic whereby traders sell holdings and then buy them back at lower prices.)
Additionally, in a bull market, investors may be tempted to sell off their investments quickly for a reasonable profit or hold on for longer if they expect prices to rise further. On the other hand, in a bear market, investors may feel compelled to sell their investments to avoid further losses. An example that perfectly illustrates this situation is the recent drop in one of the most popular cryptocurrencies—Bitcoin.
The currency witnessed a dramatic fall, with its value dropping below $20,000 in June 2022, after hitting an all-time peak of $68,000 in November 2020. Panic selling by investors is one of the main reasons for the drop in the value, particularly in light of several high-profile failures in decentralized finance (DeFi). Experts suggest that crypto stabilization depends on investors avoiding emotional and rash decisions. In general, experts recommend avoiding impulsive reactions to market fluctuations and looking at investments holistically.
Why Should You Consider Investing in a Bear Market?
In 2008, during the financial crisis, Warren Buffet said, “Bad news is an investor’s best friend. It lets you buy a slice of America’s future at a marked-down price.” The attraction of investing during a bear market lies in the possibility of making extra profits in the long run.
The idea is that buying quality assets at a “discount” will result in substantial returns when the market recovers, especially compared to the returns an investor would receive if the same assets were bought at their average price. This is often known as “buying the dip” and can be an intelligent strategy.
It should be noted, however, that some of the world’s most famous investors advise against trying to time the market. Dollar-cost averaging can be a particularly savvy strategy since investing consistently at regular intervals enables investors to buy the dip without committing too many investment funds at once.
Finally, strategizing and investing in a bear market can help investors better control emotions and handle market downturns objectively, ultimately elevating their aptitude. While it can be thrilling to witness your investments soar, it is also daunting to watch your investments plummet. Investors who understand their risk tolerance and master control over their feelings are more consistent and tend to make better returns.
Are You Ready to Start Investing in a Bear Market?
A bear market presents a potentially lucrative opportunity to boost returns and build long-term wealth. To thrive in a bear market, investors should be aware of the common mistakes investors make. Knowing and understanding these mistakes can help avoid repeating them. A few ways to offset some of the common errors are:
1. Sticking to the Long-Term Plan
As discussed, investors tend to panic in a bear market due to its volatility. Negative headlines add to the panic, often resulting in rash and irreversible decisions. It is essential to remember and stick to your long-term investing strategy. It’s also important to know that a drop in value (notional loss) is not the same as a loss unless you decide to sell the investments during a downturn.
2. Not Pausing or Stopping
In addition to avoiding a panic sell-off, it is essential to keep evaluating investments and looking for new opportunities. A bear market presents an opportunity to identify undervalued assets with considerable potential and acquire them at a discounted price. It is crucial, however, to have a strong strategy in place to re-enter the market.
3. Investing Consistently
It’s impossible to predict when the market will be bearish or bullish. However, a way to counter this problem is by making staggered investments. To ride the volatility tide effectively, it might be most beneficial to space out your investments by investing a little every month (dollar-cost averaging), rather than investing all your capital at once. Some investors even prefer greater frequencies—like daily.
4. Balancing Your Portfolio
While buying the dip can be a good strategy, it’s also beneficial to consider that some assets may be more volatile than others. The success of buying the dip depends on prices rising from the moment of purchase. Nevertheless, during times of volatility, it’s also possible that prices may continue falling. Instead of putting all your eggs in one basket, diversifying your portfolio can help alleviate risks and losses in a volatile market.
5. Correctly Evaluating Performance
It can be easy to dismiss investments in a bear market by focusing on negative returns. But calculating the returns of any investment at a low point is misleading. Thus, it is essential to ensure you are evaluating assets and their returns over long and justifiable periods. A good practice is to use a 10-year baseline while making such calculations. Sometimes it may even be best to put a pause on evaluating performance. Many investors recommend limiting the amount of time spent checking the value of your investments, especially during down markets.
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