What Makes a Bear Market?

By M. W. Byrne
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Nearly anyone who has turned on the news, picked up a newspaper or read about current events online has probably heard the terms bull and bear market. While many pundits use these words with impunity, they are often vague on the definition. We'll attempt to clarify these terms now.

Definition of Different Market Types

A bull market means an upswing in the overall averages of the exchange. These are measured by the Dow Jones Industrial average and the Standards & Poor 500 Index (S&P 500). If the exchange is in a bull stage, stock trading typically increases as more investors attempt to make money on the growth by putting their money into securities.

A bear market is the exact opposite. It is signified by a downturn in the Dow and S&P averages, which means greater pessimism by investors. During a bear market, not only does the price of securities drop, but also fewer people are willing to invest. Stock trading slows down markedly as those who have money invested wait for the prices to rebound. Simultaneously, those who are considering entering the marketplace typically wait until prices reach their lowest point. These individuals hope to be able to ride the eventual upward movement when the exchange again enters its bull phase.

What Makes a Bear Market?

It is a common misconception that any recession or drop in the Dow and S&P averages constitutes a change in the type of market. This is entirely untrue. There are stringent rules that define exactly when a bear market is in effect and when the prices on the exchange are merely undergoing adjustment. These are:

  • Percentage Drop: A drop in the Dow Industrial Average and the S&P 500 can simply be a market adjustment. It only signifies the beginning of a bear market if the total drop in averages reaches 20 percent. This means that if the Dow and S&P averages are at 12,000 points, the overall drop has to be 2,400 points (20 percent) or more in order to be considered the beginning of a bear market.
  • Time Restriction: Even if the drop in exchange prices reaches 20 percent, it might still only mean an adjustment or a mild recession rather than an overall downturn. The price drop must also continue over the course of approximately 60 days in order to be labeled a true bear market.

Investing During a Recession

While most investors will avoid making new trades entirely when the exchange rates are very poor, there is a certain kind of investing that can actually make money from severe drops in price. The method that some will use is called short selling. It is a trick where people actually sell stock they do not own.

The bet with short selling is that the price on the security shares will go down rather than up. At some point, the short seller must buy back the securities. When the price goes down, they buy the securities at the lower price and then keep the difference between the price they were sold at and the price they dropped to. If the price goes up, the short seller must buy the securities at the higher price and lose money.

Trading during downturns in the Dow and S&P averages is risky unless you intend to pursue bonds, real estate or mutual funds. These are longer-term investments that can often be bought for discounted prices when the economy is suffering. It is impossible to know precisely when the exchange will again go to bull status, so any investment could end up being a costly mistake. However, for anyone who feels like gambling, there are many opportunities during any recession.

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