What is a 'Bear Market'
A bear market is a condition in which securities prices fall and widespread pessimism causes the stock market's downward spiral to be self-sustaining. Investors anticipate losses as pessimism and selling increases. Although figures vary, a downturn of 20% or more from a peak in multiple broad market indexes, such as the Dow Jones Industrial Average (DJIA) or Standard & Poor's 500 Index (S&P 500), over a two-month period is considered an entry into a bear market.
BREAKING DOWN 'Bear Market'A bear market should not be confused with a correction, which is a short-term trend that has a duration of fewer than two months. While corrections offer a good time for value investors to find an entry point into stock markets, bear markets rarely provide suitable points of entry. This is because it is almost impossible to determine a bear market's bottom. Trying to recoup losses can be an uphill battle, unless investors are short sellers or use other strategies to make gains in falling markets. Between 1900 and 2015 there were 32 bear markets, averaging one every 3.5 years. The last bear market coincided with the global financial crisis, occurring between October 2007 and March 2009; the DJIA declined 54% during the period.
Short Selling in Bear Markets
Investors can make gains in a bear market by short selling. This technique involves selling borrowed shares and buying them back at lower prices. A short seller must borrow the shares from a broker before a short-sell order is placed. The short seller’s profit and loss amount is the difference between the price at which the shares were sold and the price at which they were bought back, referred to as "covered." For example, an investor shorts 100 shares of a stock at $94.00. The price falls and the shares are covered at $84.00. The investor pockets a profit of $10 x 100 = $1,000.
Put Options and Inverse ETFs in Bear Markets
A put option gives the owner the right, but not the obligation to sell a stock at a specific price on, or before, a certain date. Put options can be used to speculate on falling stock prices, and to hedge against falling prices to protect long-only portfolios. Investors must have options privileges in their accounts to make such trades. Inverse ETFs are designed to change values in the opposite direction of the index they are tracking. For example, the inverse ETF for the S&P 500 would increase by 1% if the S&P 500 index decreased by 1%. There are many leveraged inverse ETFs that magnify the returns of the index they track by two and three times. Like options, inverse ETFs can be used to speculate or protect portfolios.