Almost every day in the investing world, you will hear the terms "bulls" and "bears" used to describe market conditions. Because the direction of the market is a major force affecting your portfolio, it's important that you know exactly what the terms signify and how each affects you.
- A bull market is a market that is on the rise and where the economy is sound; while a bear market exists in an economy that is receding, where most stocks are declining in value.
- Although some investors can be "bearish," the majority of investors are typically "bullish." The stock market, as a whole, has tended to post positive returns over long time horizons.
- A bear market can be more dangerous to invest in, as many equities lose value and prices become volatile.
- Since it is hard to time a market bottom, investors may withdraw their money from a bear market and sit on cash until the trend reverses, further sending prices lower.
What Are Bear and Bull Markets?
The terms bull and bear market are used to describe how stock markets are doing in general—that is, whether they are appreciating or depreciating in value. At the same time, because the market is determined by investors' attitudes, these terms also denote how investors feel about the market and the ensuing trends.
Simply put, a bull market refers to a market that is on the rise. It is typified by a sustained increase in price, for example in equity markets in the prices of companies' shares. In such times, investors often have faith that the uptrend will continue over the long term. Typically, in this scenario, the country's economy is strong and employment levels are high.
By contrast, a bear market is one that is in decline, typically having fallen 20% or more from recent highs. Share prices are continuously dropping, resulting in a downward trend that investors believe will continue, which, in turn, perpetuates the downward spiral. During a bear market, the economy will typically slow down and unemployment will rise as companies begin laying off workers.
Characteristics of Bull and Bear Markets
Although a bull or bear market condition is marked by the direction of stock prices, there are some accompanying characteristics that investors should be aware of. The following list describes some of these factors.
Supply and Demand for Securities
In a bull market, we see strong demand and weak supply for securities. In other words, many investors are wishing to buy securities while few are willing to sell. As a result, share prices will rise as investors compete to obtain available equity.
In a bear market, the opposite is true as more people are looking to sell than buy. The demand is significantly lower than supply and, as a result, share prices drop.
Because the market's behavior is impacted and determined by how individuals perceive that behavior, investor psychology and sentiment affect whether the market will rise or fall. Stock market performance and investor psychology are mutually dependent. In a bull market, investors willingly participate in the hope of obtaining a profit.
During a bear market, market sentiment is negative as investors are beginning to move their money out of equities and into fixed-income securities, as they wait for a positive move in the stock market. In sum, the decline in stock market prices shakes investor confidence, which causes investors to keep their money out of the market—which, in turn, causes a general price decline as outflow increases.
Change in Economic Activity
Because the businesses whose stocks are trading on the exchanges are participants in the greater economy, the stock market and the economy are strongly linked.
A bear market is associated with a weak economy as most businesses are unable to record huge profits because consumers are not spending nearly enough. This decline in profits, of course, directly affects the way the market values stocks.
In a bull market, the reverse occurs, as people have more money to spend and are willing to spend it, which, in turn, drives and strengthens the economy.
Gauging Market Changes
The key determinant of whether the market is bull or bear is not just the market's knee-jerk reaction to a particular event, but how it's performing over the long term. Small movements only represent a short-term trend or a market correction. It's a longer time period that will determine whether you see a bull or bear market.
Not all long movements in the market, however, can be characterized as bull or bear. Sometimes a market may go through a period of stagnation as it tries to find direction. In this case, a series of upward and downward movements would actually cancel-out gains and losses resulting in a flat market trend.
Perfectly timing the market is almost impossible.
What to Do in Each Market
In a bull market, the ideal thing for an investor to do is to take advantage of rising prices by buying stocks early in the trend if possible, and then selling them when they have reached their peak.
During the bull market, any losses should be minor and temporary; an investor can typically actively and confidently invest in more equity with a higher probability of making a return.
In a bear market, however, the chance of losses is greater because prices are continually losing value and the end is often not in sight. Even if you do decide to invest with the hope of an upturn, you are likely to take a loss before any turnaround occurs. Thus, most of the profitability will be found in short selling or safer investments such as fixed-income securities.
An investor may also turn to defensive stocks, whose performances are only minimally affected by changing trends in the market and are therefore stable in both economic gloom and boom cycles. These are industries such as utilities, which are often owned by the government and are necessities that people buy regardless of the economic condition.
In addition, you may benefit from taking a short position in a bear market, profiting from falling prices. There are several ways to achieve this including short selling, buying inverse ETFs, or buying put options.
The Bottom Line
Both bear and bull markets will have a large influence on your investments, so it's a good idea to take some time to determine what the market is doing when making an investment decision. Remember that over the long term, the stock market has always posted a positive return.