What are bull and bear markets?

They are among the most commonly used words in the world of investment – but what is actually meant by the terms: bull and bear markets?

In this piece we look at the definition of each scenario, what history teaches us about them, and the impact they can have on your investment portfolio.

What is a bull market?

A bull market is a sustained period of rising equity market indices (usually of 20% or more) – and stock valuations – that can often last for months or even years. The term usually refers to the stock market. When share prices start increasing sharply it encourages more people to invest in the hope of reaping the rewards. This has a snowball effect. The more money goes into the stock market, the more demand for shares increases, prices subsequently rise, and the whole process continues at a pace.

What triggers a bull market?

So, how does a bull market start? Investor confidence plays a massive part in bull markets, both in getting them underway and maintaining momentum. They often happen during economically strong periods when countries are enjoying decent economic growth. Falling unemployment levels are usually seen, while companies make increased profits. This general wave of optimism can encourage people to try and make a profit by putting some excess money to work in the stock market.

Will all prices rise?

Of course, a bull market doesn’t mean share prices will never slip momentarily. The stock market is always a volatile place so there will be dips along the way. Similarly, companies can still endure significant losses during such periods, especially if their business models are struggling in the wake of intense competition. However, what separates a bull market from normal run-of-the-mill trading increases is when a large percentage of the equity market is rising for an extended period.

Risks of a bull market

So, what should you do in a bull market? Is the idea to buy as much as possible and ride the optimism wave for as long as possible – or should there be a degree of caution? While it can be tempting to jump on the investment bandwagon when prices are rising sharply, there’s always the risk of buying at the very peak. If prices have been inflated too far and suddenly decline rapidly, the value of your investment will obviously be heading downwards at a rapid rate.

How to play a bull market

Generally, the best way to play a bull market is to stick to your overall, long-term investment objective and not pay too much attention to such market noise. There’s an old adage that says it’s more about time in the market, rather than timing the market, as the latter is virtually impossible, even for highly experienced professional investors. It’s usually a much better idea to stick to putting regular amounts in – irrespective of how markets are performing – in order to benefit from the concept of pound cost averaging.

What is a bear market?

Unsurprisingly, the opposite of a bull market is a bear market. Generally, a bear market will follow a sustained bull market and is usually defined by 20% price falls from the peak. In much the same way as a bull market picks up momentum, a bear market sees nervous investors heading for the exit before they suffer substantial losses. As money flows out of the stock market, demand will drop, and share prices will fall. However, there are potential positives for canny investors to take advantage of such weakness.

What causes a bear market?

Declining investor confidence is often a trigger for a bear market, and this can happen for a number of reasons. For example, widespread anxiety that the bull market has gone on too long and some stocks are now looking overvalued can be enough to see the beginning of a sell-off. It may also be due to other factors. For example, there may be economic problems causing people to tighten the reins on their finances or a global war that could have implications for many stocks.

Will all prices fall?

While many prices will be heading south, it doesn’t mean that every company will see their valuations fall through the floor. There is still likely to be some stocks that withstand bear markets without their share prices being too adversely affected. They will often be companies that deliver better-than-expected returns or make a move – such as a takeover – that analysts believe will be good news over the longer-term.

What to do in a bear market

It’s difficult not to get spooked in a bear market and sell out of positions. However, it’s worth noting that you only crystallise the losses when you sell. There’s always the option of holding onto the shares, riding out the wave of share price declines, and then reap the rewards when the dark days pass. Braver investors can even take advantage of share price weakness to buy more stock in companies that they believe have good longer-term prospects.

*Source: Vanguard

 

Photo by David Clarke on Unsplash

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