Bear Markets: a complete beginner’s guide

When you’re first getting started as a trader, you’ll begin to hear the term ‘bull market’ and ‘bear market’ thrown around a lot.

If you’re not sure what they mean yet, don’t worry. We’re going to explain both in-depth in two guides. We’ve already covered bull markets in part 1.

Today, we’re going to take a look at bear markets.

Bear markets still offer potential for profitable trading, but there are a lot of potential pitfalls and risks that come with them. The more you take the time to educate yourself, the better your chances of trading success in these more volatile environments.

We’re here to help. So, let’s get started:

So, what is a ‘bear market’?

A bear market is simply a market in which the majority of assets are going down in value.

So, it probably won’t surprise you to learn that most traders don’t like them!

Usually, when you see traders talking about ‘bear markets’ in the press or on the news, they’ll be talking about a bear market in stocks, but any asset can go through a bear market.

If commodities, for instance, started to fall across the board, that would be a bear market for commodities.

When crypto prices were low in 2019, that was a bear market for crypto. (Though it was given the more ominous name of ‘crypto winter’.)

Falling prices and higher volatility make bear markets risky periods for traders.

What are the key characteristics of a bear market?

A fall in asset prices is obviously the key characteristic of a bear market. But there are a few other factors which usually come into play at the same time:

A lack of confidence from traders

It’s human nature to want to preserve what we have in risky times.

During bear markets, with asset prices falling and profitable trades harder to pinpoint, traders understandably tend to be less optimistic and less confident about trading as a whole.

A weaker economy

If the economy is weak, companies are more likely to struggle. Then, when the companies announce poorer performances, traders are less likely to want to trade their stock.

In turn, their share prices can fall, causing more volatility in an already tough economic environment.

As you can see, weaker economies tend to correlate with bear markets.  
 

Less activity and potential liquidity issues

If you don’t have confidence in the markets, you’re less likely to trade full stop.

This means that bear markets will usually mean a drop in trading activity as a whole. (And in some cases, potential liquidity problems in assets that were already less liquid.)

Traders are simply more likely to stay in cash and wait for markets to improve.  
 

Lower consumer spending

It’s not just traders that get more cautious in a bear market. Consumer spending tends to do the same.

Again, this makes sense if you think about it:

Bear markets are always reported on the news. Consumers see the reports and become worried about the economy.

Often, this leads to them cutting their spending and focusing more on saving the money they do have.

(Consumer borrowing usually declines in a bear market, for the same reason. The lack of confidence means consumers are less likely to want to take on debt.)

Less IPOs

Companies are (rightly) more cautious to go public when trader confidence is low.

In bear markets, traders feel more uncertain. They’re naturally nervous about volatility.

Unfortunately, IPOs are by nature uncertain. There’s no real way of knowing how a newly listed company will perform, and this makes the already nervous traders wary of trading the IPOs.

In turn, this means any company going public during a bear market risks raising less initial capital than they would if they waited until market conditions improved.

The time of the ‘safe haven’ assets

In bear markets, when stocks are down, you’ll often find certain ‘safe haven’ assets will increase in value.

Throughout history, these assets have traditionally performed well in the worst market conditions, so many traders see them as the ‘safer’ option during volatile periods.

The main three ‘safe havens’ are usually considered to be:

• Gold
• Government Bonds
• Currencies/Forex

Though, of course, all assets can go up or down in any market. Nothing is guaranteed.

Note: Past performance is not indicative of any future results. This information is provided for informative purposes only and should not be construed to be investment advice.

How do traders try to generate returns during a bear market?

Short trades

When you place a ‘short’ trade, instead of that the price of the asset will go up, you speculate that it will fall.

In a typical ‘long’ trade, if the share price increases by 15%, you profit 15%.

With a short trade, you profit by 15% if the share price falls by 15%.

Shorting directly can be quite in-depth and complex, and it can also incur extra fees and charges.

That’s why many traders prefer to use trading tools like spread-bets or CFDs, which allow you to place long or short trades using the same step-by-step process.

(For a more comprehensive explanation, check out our guide to shorting here.)  
 

A warning about short-selling

One of the key risks you always need to consider when shorting is that you can lose more than the amount of money you put into the trade.

Even if you aren’t using leverage.

And unfortunately, until you close the trade, these losses can theoretically keep piling up because the stock price could continue to increase. And there is no limit on how much it could increase by.

This potential for unlimited loss is part of the reason many traders avoid shorting altogether.

Value stocks can out-perform growth stocks

One key point you’ll need to understand as a trader is the difference between so-called ‘growth’ stocks, and what’s known as ‘value’ stocks:

• Growth stocks are stocks that are part of a strong upward trend at the present time
• Value stocks are stocks that traders believe are currently trading for less than they’re really worth

As a general rule, the worst bear markets tend to be more brutal to growth stocks than value stocks.

Let’s take a look at an example:

This chart shows the performance of growth stocks against value stocks within the S&P500 over the past 30 years or so.

(When the line falls, that means value stocks are getting stronger against growth stocks.)

The purple bars represent the four biggest bear market periods within that time. As you can see, the evidence that growth stocks tend to decline during those bear markets is compelling to say the least.

During bear markets, it’s often worth trying to focus more on value stocks than growth.

(Though it probably won’t surprise you to learn that picking out ‘value’ stocks is not easy. It’s a skill traders spend years developing, and there are many books written on the subject. If you want to read more online, this guide from Charles Schwab is definitely worth your time.

Consider the forex market

Forex markets have a unique characteristic that can make them valuable during bear markets.

See, all currencies are traded in what’s known as currency ‘pairs’. This means that you’re always trading the value of one currency against the other.

In other words, no matter the market conditions, there are always forex currencies increasing in value. Meaning there are always profit opportunities within the forex markets.

Forex markets can also provide a potential hedge against any bear markets limited to a particular region.

So, let’s say that the UK is going through a stock bear market and dealing with a weak economy. But, at the same time, the US stock market (and economy) is performing well.

You’d usually expect the British Pound to devalue against the US dollar in this situation, which gives you the opportunity to profit.

Look for opportunities

There’s a saying among traders that goes something like this:

“The stock market is the only market in the world where everything goes on sale and all the customers run out of the store.”

In other words, if prices are all down, there is an opportunity for traders to buy at low prices now, and then sell-up once the markets have recovered.

This sounds simple enough, and it is. But psychologically, it’s very tough to buy when everyone else is selling! It’s human nature to move with the crowd.

As Jesse Livermore put it:

“Trades have to reverse what you might call his natural impulses. Instead of hoping he must fear; instead of fearing he must hope.”

And, of course, the other risk factor is that not all assets that tumble in a bear market will recover. Many will remain at their new – much lower – price, and others will collapse entirely.

As with all trading, it’s about doing the necessary research to make sure you know as much as possible about the asset you’re planning to trade.

The more time you spend improving your knowledge of the markets, the better your chances of becoming a profitable trader.

And remember, always keep this key rule in mind:

You should never trade with capital you cannot afford to lose. 

So, let’s sum up everything we’ve covered here:

• A bear market is simply a market in which assets are largely going down in value
• If you hear someone on the news talking about a bear market, they’ll usually be talking about stocks, but a bear market can happen in any asset
• Key characteristics of a bear market can include low trader confidence, low consumer spending, a weak economy and less companies going public
• Traders can manage bear markets by (among others) focusing on short trades, targeting value rather than growth stocks, taking advantage of the forex markets, and taking advantage of lower prices before they increase