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How to Identify Bull and Bear Market Trends

Views 6647Nov 1, 2023

Key Takeaways

Bull and bear market trends are of great importance to traders, with varying market conditions pointing to the potential for profit (or the potential for a loss) within differing strategies. In this guide, we look at the identifying factors of bear and bull markets.

Bull Market VS. Bear Market

If you’re unfamiliar with these terms, a bull market vs. a bear market may sound entirely unrelated to investments. However, many believe this connection is derived from the approach each animal takes when attacking a threat - a bull will point its horns upwards (signifying an up market), while a bear will swipe downwards (signifying a down market). Others believe the term originated with Shakespeare’s references to bulls and bears across multiple plays.

What is a bull market?

A bull market occurs when prices are either rising or expected to rise, within a financial market. While this term is most often applied to the stock market, it’s also colloquially used for any market in which assets are traded, including bonds, real estate, commodities, and currencies. Bull markets may last for months, or in some cases, years, but the term is reserved for consistent, extended periods within which numerous security prices are simultaneously rising.

One of the most notable recent bull markets occurred between 2003 and 2007, when the S&P 500 increased by a sizeable margin following a previous decline.

What is a bear market?

A bear market is the opposite of a bull market, signified by consistent decline. The mark of a genuine ‘bear’ market is considered to be a 20% or more fall from recent stock price highs. Bear markets are characterized by continuous dropping in share price values, resulting in a downward trend overall. Bear markets are a sign of economic downturns, with unemployment rates often simultaneously rising as a result of company layoffs.

Characteristics of Bull and Bear Markets

Bull and bear markets are defined by notable characteristics. Signs of a bull market include:

A strengthening or strong economy. Bull markets are more likely to take place within the safety of a well-performing economy, most often aligning with strong gross domestic product, reduced unemployment and rises in corporate profits.

Increasing investor confidence. Bull markets are driven by strong demand for stocks.

While some of these characteristics can be clearly quantified, others are less tangible, such as the tone of market commentary. Astute investors who monitor for bull and bear patterns learn to draw on multiple sources of data and context in order to inform their corresponding investment strategy, leaning on qualitative and quantitative insights alike.

Characteristics of bear markets include:

Declines in overall market or index values

Declines in individual stocks, securities or commodities of 20% or more from recent highs

Economic downturns and recessions

Bear markets follow four clear phases that further define their duration:

Phase 1: high prices and high investor sentiments. As this phase reaches its completion, investors begin to realize profits and exit markets.

Phase 2: A decrease in stock prices, trading activity, and corporate profits. Many economic indicators will begin to fall below average, with many investors moving into panic as the market begins its turn. This phase is referred to as ‘capitulation’.

Phase 3: Here, speculators begin to enter the market. This leads to an increase in prices and trading volumes.

Phase 4: In a bear market’s final phase, stock prices continue to drop, but at a slower rate. The combination of reduced prices and positive news entices investors back, who enter into the market, shifting a bear market to a bull market.

Supply and Demand for Securities

Across bear and bull markets, supply and demand for securities will experience swings in both directions. During a bull market, demand will be stronger than supply, with more investors looking to purchase securities than to sell them. In a bear market, supply outpaces demand, leading to a decrease in stock values.

Investor Psychology

Bear and bull markets are directly correlated to investor psychology. Market behaviour is greatly impacted by the responses individual investors have to its patterns, meaning investor psychology can lead to increases or decreases in market values. During bull markets, investor psychology is positive, with many investors looking to participate in the hopes of realising a profitable outcome. In a bear market, investor psychology continues to impact market results, with the increase in investors looking to sell off their investments leading to declines in stock market prices. This causes a decrease in investor confidence, which has a further impact on declining prices. [1]

Moomoo offers investors the benefits of its Interpretation of Indicators feature, which enables investors to view a Sentiment Indicator within the moomoo app. This dashboard shows the overall status of all technical indicators, as well as the ability to switch to view varying candle chart periods.

Change in Economic Activity

Economic outcomes are tied to stock market patterns, with the value of stocks impacting the fates of participating businesses. Bear markets are correlated with weak economies, with the majority of businesses unable to create significant profits due to a lack of consumer spending. Continued declines in profits create further negative investor sentiments, which can then lead to a further decline in market values.

This is reversed within bull markets, with consumers strengthening economic performance through increased spending. Growth in company profits can encourage investor sentiments, leading to further increases in individual stock values.

How to identify bull market trends

There’s no guaranteed way to identify a looming bull market, as these are defined by continued investor confidence and optimism over extended periods of time. Given the variables in the mix of what contributes to a clear, tangible bull market, the most commonly used definition is the measurement of stock prices rising by 20% or more from recent lows over a consistent time period. The difficulty in predicting bull markets is why they’re more often recognized once they’ve completed, rather than before they begin.

While bull markets can’t be entirely guaranteed, these significant trends can point to their ongoing nature.

Stock market performance

During a bull market, stock markets will see increases in values, with positive market sentiment informing many investors’ strategies. The continued upturn in stock market prices will increase investor confidence, reinforcing further increases.

Change in GDP

Bull markets are also often linked to increases in gross domestic product, signifying healthy economic climates that can increase investor confidence.

Rate of inflation

Booming economies can potentially lead to issues with price inflation, as high demand for products and services leads to increases in prices within bull markets.

Prevailing interest rates

Prevailing and increasing interest rates can often lead to increases in stock values, with bull markets often accompanied by high interest rates.

How to identify bear market trends

As with bull markets, identifying exactly when a bear market is likely to commence is difficult, with multiple factors leading to bear market conditions. However, if the growth prospects of multiple stocks continue to wane, decreasing investor confidence, this can lead to an ongoing decline in stock values. This decline often leads to herd behaviour, with investor panic creating further downward losses and decreased asset prices.

Stock market performance

During a bear market, stock markets will decrease in value, with fear informing many investors who look to sell their stocks to reduce their potential losses. This can have a snowball effect, further decreasing asset values, and continuing to create an environment where supply outweighs demand.

Change in GDP

Decreases in GDP, which can be signifiers of poor economic outlooks, are linked to bear markets. Reduced company earnings can lead to rising unemployment, negatively impacting GDP results.

Rate of inflation

Bear markets can often coincide with governmental attempts to reduce inflation, with bull markets leading to price inflation. As methods to curb inflation are introduced, this can have a detrimental impact on consumer and investor risk capacities and access to investment funds, leading to a reduction in certainty in the economic outlook.

Prevailing interest rates

High interest rates can ultimately mark a downturn in a bull market, resulting in a shift to a bear market, as investors look to meet new obligations within their debt repayments.

What if it's neither?

Conditions will occasionally result in an environment that’s neither a bear nor a bull market. In these instances, this is called a neutral market condition, with prices not rising or falling more than 20% on a consistent level. During a neutral market, price fluctuations can indicate a bear or bull market is on its way, but they don’t guarantee these outcomes.

Gauging market changes

Investors who are monitoring for bull or bear market conditions will look not only at a market’s instant reaction to individual events but to long-term performances, rather than market corrections. While an upwards or downwards movement may point to a likely bull or bear market, not all long movements will lead to one of these two outcomes. A series of upwards and downward movements can cancel out gains and losses, creating a neutral outcome.

What strategies may work in a bull vs bear market

During a bull market, investors have the opportunity to purchase stocks early in the trend, holding onto them until they reach their peak. While losses may occur during a bull market, these are generally only temporary.

In a bear market, the risk of a loss on investment is increased, as prices continue to lose their value without a clear low point in sight (you can read more about how to invest in a bear market here). Investors who buy within this market are more likely to see a loss before an upturn occurs. In a bear market, profitability often resides within less risky investments, including fixed-income securities. Defensive stocks can also offer investment opportunities, offering stability in both bear and bull markets.

Investing in the long-term

Investors facing a bear market may begin to question if they should reallocate their portfolios to pursue long-term success. While the answer to this will differ for each individual, consider the following factors:

Investment goals - what are you looking to achieve with your investments? If you sell your stocks, how can you achieve these elsewhere?

Time horizon - how much time do you have to achieve your investment goals? Can you ride out a bear market in the hopes of selling during a bull market upturn?

Risk tolerance - how much can you afford to risk within the unknowns of bull and bear markets?

As history has proven that bear markets don’t last forever, these considerations can help investors shape a market strategy that’s customized to their individual circumstances.

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[1] Bull vs. Bear Markets: What They Mean for Investors - BCSC InvestRight

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