A bear market is characterized by prevalent market pessimism and declining stock prices. This negativity causes people to sell, which, in turn, causes more doubt about the market’s stability. However, if you play your cards correctly, you might be able to turn a profit—or at least protect yourself—in a bear market.
Bear and bull marketsThe bear and the bull are symbols of the financial market. When stock prices go up, people buy and investors turn a profit; the bull is the emblem of this market. When stock prices drop, people sell and investors lose money on previously lucrative shares; the bear symbolizes this. Unemployment and rising inflation often accompany a bear market.
Continue Reading Below
Wojtek Zarzycki, chief investment officer at Optimal Investing, said, “A generally accepted rule is that a bear market occurs when prices have declined 20 percent or more since the most recent top.”
Risks of a bear marketDavid Twibell, president of the Custom Portfolio Group, said that when markets decline, investors tend to throw away their investment strategies, sometimes selling stocks and loading up on cash and bonds. However, they will have to watch as the market recoups its losses without them. Twibell explained, “The risk of making emotionally-driven investment decisions is incredibly prevalent during bear markets, which often tend to be much more violent and short-lived than bull markets.”
Finding the bottom Another risk of a bear market is guessing when the market will bottom. Many investors jump in when stocks are falling to take advantage of the distressed prices, but the market very often will continue to fall.
Twibell offered this advice: “Wait until the market bottoms before deploying your cash. You may not get the glory of buying at the absolute bottom, but you will almost certainly do a better job of protecting your portfolio and generating better long-term investment results.”
Weak economyThe hazards can extend far beyond an investor’s concerns for her or his own stock options. The declining stock prices of a bear market can disrupt the economy, thus disrupting the stocks again. This creates a cycle of economic weakening. Lower returns will make people less likely to spend.
Michael Farr, president of Farr, Miller & Washington, explained, “Consumer spending accounts for about 70% of GDP in the U.S. Therefore, a drop in consumer spending leads to lower demand, which would cause slower economic growth or even a recession.” Farr highlighted how this self-reinforcing cycle can lead to widespread layoffs, magnifying the economic downturn.
Silver liningAlthough it is clearly much harder to make money during a bear market, it is possible. Zarzycki explained, “A common misconception is that investors can only make money in a bull market. With the ability to short stocks and use different types of derivatives and options, investors can make money in a bear market as well.”