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Trading in a bear market

The definition of a bear market is one that has fallen in value by more than 20% for over a two-month period, during a period of widespread market pessimism. This fall is often due to investor fears about a country's economic outlook. A bear market can offer opportunities for traders to find a good entry position, and multiple short-selling opportunities.

Modern traders can trade a bear market by using popular derivative tools such as spread bets and contracts for difference (CFDs). This type of market can come with many risks, and therefore, traders are advised to create an efficient bear market trading strategy​​ in order to reduce losses as much as possible. This article explains the meaning of a bear market, along with examples from the financial markets, and how you can profit in a bear market.

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What is a bear market?

A bear market occurs when prices have fallen in value by more than 20% from recent highs, during a period of negative market sentiment.

The financial markets naturally grow and contract due to changes in supply and demand. This constant change is caused by fundamental economic factors influencing the natural buy and sell cycle of an economy. This gives rise to bull and bear markets. A full-on bear market shouldn't be confused with shorter-term corrections of a bull market. It's almost impossible to predict when a bear market will occur, or how long it will last for. It is equally as difficult predicting the end of a bear market and this makes trading these markets especially tricky.

The most recent bear market was during the global financial crisis, when the Dow Jones Industrial Average fell 54% from October 2007 to March 2009. This bear market crash offered astute traders numerous opportunities to short sell the global index markets and individual securities.

When prices start to rise in a bear market, usually after a downtrend, this can lead to bull traps​​.

US 30 index chart showing the bear market during the Global Financial Crisis of 2007-2009

Types of bear market

There are a number of different types of bear market. These tend to have a different length, impact and subsequently, recovery time. This is because different bear markets produce different kinds of recessions, some of which are more damaging in the long-term to a country's economy. Here, we explore three different types of bear market that are commonly witnessed.

Cyclical bear market

A cyclical bear market tends to happen at the end of a business cycle, where there appear to be high inflation rates and rising interest rates, along with declining overall profits. This results in a damaging outlook for economic growth and future potential. This type of medium-term bear market declines less than structural bear markets and lasts for around 25 months on average. Read about the different types of cyclical stocks​.

Structural bear market

A structural bear market is associated with stock market bubbles​ and imbalances within the economy. An example of a structural bear market would be the 2007-2009 Global Financial Crisis. These types of bear market are usually linked to banking crises, where they over-extend debt loans to individuals. A structural bear market tends to last the longest, with an average length of 3.3 years and recovery time of 9.2 years.

Event-driven bear markets

This type of bear market is triggered by global events that have an impact on the economy, including wars, oil shocks, pandemics and even terrorist attacks. Some examples include the Covid-19 virus and 9/11 terrorist attacks. Event-driven bear markets tend to decline the least and recover so the fastest, so it is the shortest form of bear market.

Bear market characteristics

Below are some characteristics of a bear market that analysts and economists look out for. Spotting two or more of these circumstances is a good indication that the economy is entering (or has entered) a bear market.

  • Stock prices start to fall.
  • Negative investor sentiment. Investors sell current holdings and hold off on buying more shares.
  • Economy spending declines, leading to deflation.
  • Corporate earnings decrease.
  • Higher unemployment levels and cut to research and development.
Trade during potential bear markets

Trading a bear stock market

The typical bear market short trade would be based on an underlying trade idea. This incorporates the target asset and the price that a short trade should be initiated at.

Shorting a market index​​ such as the S&P 500 is a popular choice with traders as this index represents a basket of underlying stocks. Their popularity is founded in their accessibility for most traders as well as their technical and highly tradeable trends. Some traders prefer to target the underlying stocks themselves.

Exchange-traded funds​​ (ETFs) are marketable securities that track a basket of securities, a stock market index, bond or commodity. ETF trading usually has more liquidity and lower fees than mutual funds, making them a popular choice for traders wanting to short a bear market. Inverse ETFs provide a useful tool to either speculate for profit or to protect a stock portfolio.

Bear market trading strategy

When deciding on a trading strategy for a bear market, an important decision is which type of trading vehicle should be used: contracts for difference (CFDs), futures or options. A CFD is a popular form of derivative trading that allows a trader to speculate on an asset by going short during a bear market. It is an agreement between the trader and the CFD provider to pay each other the difference between the opening and closing prices of a financial instrument. CFDs allow traders to gain exposure to an asset without having to own the underlying asset. CFDs are often leveraged, which allows traders to hold larger positions than the actual value of the amount they invest to open the trade. Read more about what CFDs are here.

Open a demo account to start practising trading with CFDs in a bear market.

Trading options is another useful tool in a trader's investment strategy. Put options give the owner the option to sell a stock at a specific price on, or before, a certain date and can be used to hedge against falling prices. Call options provide the opportunity to buy at a certain point in anticipation of an asset rising, meaning buyers can acquire the stock for a lower price and then sell it for a profit. The strike price is usually used to identify the contract price at which a derivative can be bought or sold. Options are very similar to forward contracts, which are available on our platform to help traders weather the bear market.

How to profit in a bear market

Traders increase their probabilities of trading market trends by having a stringent trading strategy and capital management plan. This applies equally when trading both bull and bear markets. There are some important aspects worth considering when attempting to trade a bear market.

  • A bear market can move rapidly so it is wise to choose trades cautiously and manage risk​​ appropriately. During bear markets, it is possible for investors and traders to be successful by seeking out and buying good value stock portfolio propositions during a falling market. Dividend stocks in a bear market may still pay healthy dividends or can be sold later if they recover their value.
  • Traders need a range of investment strategies to maximise their profits and minimise their losses. This includes various forms of hedging and short selling. Short selling stocks​​ is where traders profit by selling borrowed shares and buying them back for less at a later time.

Bear vs bull market

Essentially, bull and bear markets are either going significantly up or down in value and market capitalisation. A popular bull and bear market definition traces the terms back to how each animal attacks. Bulls drive up with their horns. Bears rake down with their claws.

In a bull market, share prices rise steadily off the back of investor confidence. This confidence increases demand and keeps supply low. A characteristic of a bull market is that price action​​ is usually steady without major whips and stalls. It can continue in this fashion for many years; however, markets cannot remain bullish forever. The balance between demand and supply will naturally change leading to price corrections​​. They are not always severe enough to be classified a bear market. A great example if this would be the 12 months that the S&P 500 index stalled during 2015/16. Price action dropped 14.5%, which is not enough to fulfill the definition of a bear market. As such, this period was just a price correction in a bull market.

Read more about the history of bull markets​​.

US NDAQ 100 chart showing a steady bullish uptrend followed by a rapid bearish decline

How frequent are bear markets?

One of the major characteristics of a bear market is that it is usually influenced by widespread investor fear over the future outlook for an economy. This fear leads to panic selling, which causes large drops and spikes in price movements. These periods are often fraught with scare mongering in the press as market proponents predict financial conflict. As such, bear markets tend to feed themselves and become, to an extent, self-perpetuating.

Since 1990, there have been two bear markets that were both two years in duration. Although price movements were more volatile and severe than the preceding bull markets, they did come to an end. This in turn gave rise to the next bull market that would then run on further and longer than the last.

US SPX 500 chart showing bullish (in green) and bearish (in red) periods

How to weather a bear market

All traders need to set up an effective risk-management strategy in order to minimise risk if the markets go against them. This is less of a problem in a bull market when there are likely to be opportunities to recoup former losses by buying a security as it is revalued higher. But trading in a bear market can be more difficult. To keep your head when everyone in the financial market​ is stampeding towards the exits requires the ability to be decisive and act quickly. And this has to be backed up by a solid understanding of the technical resources that are available to help manage your trading account.

The standard trade management tools apply in a bear market. In particular, that means ensuring appropriate trade execution orders​ have been used. A stop-entry order is simply an order to buy or sell a security when its price moves past a particular point. A limit entry order​ can help to diversify a trader's game plan by making it possible to short into rallies in a bear market. These orders bring some predictability to a trading strategy by making sure trades are executed at a predefined price. Some traders prefer to take more active control of their account and not to be automatically taken out of their position.

Stop-loss orders​​ are a useful tool to close an open trade that is going against you at a predefined price level to limit the loss of capital. However, markets can move fast and this is often the case when they turn bearish. Bear markets don't head down continuously – prices may pull back from time to time. This means traders may risk being stopped out when the market was simply consolidating, rather than making a fundamental shift.

Traders aren’t always guaranteed to get closed out at the price they set their stop-loss orders at, which is known as slippage. The faster the market moves, the greater this slippage can be. To circumvent this, you might choose to trade an option with a strike price where a stop-loss would have been located. This could allow you more time to evaluate whether or not you are truly in a losing position.

Practise trading in the bear market

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Where to invest in a bear market

Our award-winning online trading platform, Next Generation, allows traders to speculate on the price movements of an endless number of assets. Bear and bull markets are clearly displayed through charts and graphs, which you are able to customise to suit your own trading strategy. Take advantage of our price projection tools, drawing tools and technical indicators, which are all included within our charting features. Watch more platform tutorials​ here.

What's the difference between a bear market and a recession?

A bear market describes a period of trending downward stock prices, often as a result of negative investor sentiment. However, a recession can be defined as poor economic health that is monitored over at least two consecutive quarters of the financial year, often measured through gross domestic product (GDP).

Bear markets can often lead to or go alongside with an economic recession, although they can also provide effective trading opportunities for investors.