Do you know why it is called a bear market? Bear markets happen when there is a 20% downturn or more in stock prices over a sustained period, specifically over two months or more. What results from a bear market is a loss in investor confidence and subsequent panic selling for fear of further losses. Sadly, this fuels a vicious cycle of negativity and continued selling; welcome to the bear market. Take the Dow Jones Industrial Average, for example; it hit its record high of 26,828.39 on October 3, 2018. We would be in a bear market if it fell 20 percent to 21,462.71.
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It’s called a bear market when the stock market falls over 20% over two months or more. The stock market is made up of the bulls and the bears. Bulls try to push prices up, and the bears try to counterattack by pushing prices down.
As I explained in other blog posts, what goes up must come down like a roller coaster. This analogy can be applied to the stock market. A lot of times, the behavior of stocks follows a predictable pattern.
Consider when a sector is doing well, earnings are on point, and confidence is high. Investors want to get in on this hot sector, so they purchase large amounts of stocks, prices continue to rise, more people jump in on the action, and life is good. We call this a bull market.
After a while, the mood changes, and people start to become wary. This indecision, or fickleness, is reflected in the market. Investors are growing increasingly pessimistic, and fear stock prices might start to reverse.
What do they do? Well, they start to sell off their investments to protect their gains.
Sadly, panic selling can cause a chain reaction of widespread panic selling, akin to a domino effect. And this, my friend, is the start of a bear market or the roller coaster ride down. The result is a plummeting of stock prices, decreased trading activity, and low dividend yields.
Eventually, the downward ride levels out, and investors return to capitalize on the low stock prices. They reinvest in the market; confidence grows, prices rise, and the ride upwards and transition to a bull market begins.
Where Did the Term Bear Market Come From?
To an outsider unfamiliar with the stock market, the terms bull and bear market might sound ridiculous. I know they did to me when I first started. Why is it called a bear market?
I remember thinking, “You can’t be serious; you’re referring to the stock market regarding four-legged furry wild animals?” What the heck am I getting myself into here?” The terms are quite clever.
Think back to movies you have watched where a bear attacks; how do they attack? Typically, a bear will swipe its paws at its prey, hopefully not you, in a downward motion. That’s why falling markets and stock prices are referred to as bear markets!
On the other hand, a bull market is the opposite of a bear market; confidence is high, stock prices are rising, and optimism is the prevailing mood of the investors. Now, please think of how a bull attacks its prey.
A bull attacks its prey by charging with its horns thrusting upward into the air; this is where we get the term bull market.
Indexes
Why is it called a bear market? For one thing, Index funds such as the Dow Jones Industrial Average (DJIA) or the S&P 500 (SPY) are usually good indicators of what the overall market is doing.
When they’re red, it means the overall market is weak. If they are strong, then the overall market will be going higher. When the market is weak, it means that the majority of stocks are selling off. It doesn’t matter if it is Apple, Tesla, Facebook, Amazon or Alibaba. When the market is strong, the prices of most stocks will go higher.
Similarly, if someone says the market is “bearish” or “collapsing,” they’re not referring to a specific stock. They mean the whole stock market is losing value – all stocks together.
The same is true for specific sectors. Take the pharmaceutical sector, for example; when it is weak, all other pharmaceutical companies lose their value.
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20% Drop
A 20% stock price drop doesn’t automatically mean we’re heading towards a bear market. What’s needed is a sustained period of lower lows in the major indices. Conventional wisdom says it usually lasts 18 months. The average length of a bear market is 367 days.
Another key point is that recessions accompany BM’s, where the economy stops growing and contracts. The result is layoffs and high unemployment rates.
With this in mind, you can recognize a bear market if you know where the economy is in the business cycle. A bear market is unlikely if it’s just entering the expansion phase.
However, if the economy is in an asset bubble or investors behave with irrational exuberance, rest assured, it’s probably time for the contraction phase and a bear market.
Is It a Bear Market or Just a Correction?
As I mentioned earlier, what goes up must come down. It’s the amount of downward fall that matters.
If prices drop more than 20%, the fall is referred to as a bear market. Conversely, if the fall is only about 10%, this is referred to as a market correction. Hence, knowing why it is called a bear market is important.
The purpose behind a market correction is just that: to correct something that has gotten a bit off course. In the case of the stock market, this could be an unjustified rise in price.
Market corrections tend to last no longer than two months, whereas bear markets last longer than two months. To put this in perspective, between 1900 and 2013, we experienced 123 market corrections and 32 bear markets. The average market correction lasted ten months, with the average bear market lasting approximately 15 months.
On a positive note, they are typically shorter than bull markets, which surely bodes well for investors.
Final Thoughts: Why Is It Called a Bear Stock Market?
If you didn’t already know, the saying “It’s not how much you make, it’s how much you keep” came from bear markets. Unfortunately, a ferocious bear market can wipe out years of portfolio gains. A strategy you may seek to employ during bear markets is covered calls.
It would be best if you learned how to trade in bear markets. Money can be made in a bear market. This is especially for those who short-sell.
Frequently Asked Questions
- There are several different causes for a bear market:
- Economic slowdowns
- Increasing unemployment
- Investor sentiment
- Bad company earnings
- Falling stock prices
- Asset bubbles
- Global manufacturing slowdown
- 2008 financial crisis: unforeseen
- Coronavirus: unforeseen
