What Is A Bear Market. How Should You Trade Or Invest In One

There are 2 ways to define a “bear market” vs a “bull market”.

A state of mind (investors’ psychology)

A quantitative method.

In terms of investor psychology, a bear market is “prolonged period of falling market prices in which the downwards decline becomes a self-fulfilling prophecy”. This means that there is widespread pessimism among investors and traders. Investors/traders sell because they expect prices to fall. Prices fall, so investors/traders expect prices to fall even more. They sell, then prices fall even more. It’s a vicious cycle.

This means that the market’s medium-long term trend is going down even though there may be bear market rallies along the way. Bear markets are characterized by:

General investor pessimism (expectations that the market will fall in the medium-long term).

Negative or deteriorating fundamentals. Each market’s “fundamentals” are different. For example, the stock market’s fundamentals are the economy and corporate earnings. The economy deteriorates in an equities bear market.

The key phrase here is that prices are trending lower in a bear market. But how do you define this concisely? How much do prices need to fall for it to be a bear market? How long do prices need to go down for? A TIME definition is just as important as a MAGNITUDE definition.

That’s where the quantitative method comes in. The generally accepted definition of a “bear market” is a decrease of 20% or more for the stock market that lasts at least 2 months from top to bottom.

*Other markets define this differently. For a highly volatile market like silver, a 20% decline is merely a “correction” and not a bear market. The stock market is less volatile than commodities.

Problem with the standard definition of a bear market

I don’t like it when the conventional wisdom defines a “bear market” as a 20% decrease in prices.

Why 20%? Why not 21% Why not 19%? Why not 18%? Why not 25%?

This is a silly technicality that many investors and traders seem to get caught up in. They consider the 2011 stock market decline to be just a correction because the S&P fell 19.3% when you use the CLOSE prices. But the S&P fell 21% when you use the HIGH and LOW prices. They don’t consider this a “bear market” on the mere account of 0.7%.