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A bear market is a sustained period wherein major stock indices fall by 20% or more, followed by low investor sentiment and slow economic activity. These periods usually occur when earnings fall, macroeconomic risks grow, or external shocks disrupt financial stability. Although alarming, bear markets are a normal aspect of long-term market cycles and frequently cause investors, analysts, and policymakers to reconsider valuations, capital allocation, and wider economic circumstances.
Key Takeaways
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Bear markets are associated with negative emotions, lower trade activity, and economic slowdowns.
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They often unfold in phases, starting with optimism and ending with progressive recovery.
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During downturn markets, specific methods such as diversification, staggered investment, and defensive repositioning are frequently considered.
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Short selling, put options, and inverse ETFs are some of the tools used to profit from dropping prices, but each has its own set of risks.
What is a Bear Market?
A bear market is typically defined as a prolonged period during which a broad market index declines by 20% or more from a recent high, and the weakness persists for at least two months. It is usually associated with negative returns, pessimistic market sentiment, and increased selling pressure that further weighs down prices.
The decline in stock prices can be caused by several factors, such as panic selling by investors triggered by an economic crisis, such as an unexpected catastrophic event, a financial crisis in one sector, a market correction, or a decline in corporate profits. Hence, the bear market can be difficult on both new and seasoned investors.
The best approach to a bear market would depend on the investors’ time horizon, investment objectives, and risk tolerance. While most fear bear markets, it can be the best opportunity to grow your portfolio and prepare the groundwork for long-term wealth building.
Also Read: What is Market Sentiment?
Understanding the Phases of a Bear Market
Bear markets are often described in four phases, which are as follows:
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Phase one (recognition): Here, prices are high, and sentiment is positive. However, early investors start selling to lock in gains, but most participants still believe the market will rise.
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Phase two (panic and capitulation): Prices decline, trading activity slows, company earnings fall, and economic data becomes negative. As fear grows, many investors sell to limit their losses, a process known as capitulation.
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Phase three (stabilisation and false rebounds): Prices stabilise at lower levels, and speculators participate, resulting in a temporary increase. These rebounds are fuelled by short-term purchasing rather than a shift in fundamentals.
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Phase four (bottoming and early recovery): Prices decrease gradually and settle in lower levels. Conditions begin to improve, negative news reduces, and steady purchasing interest returns. This phase frequently precedes a fresh bull market.
What To Do In a Bear Market?
Severe bear markets may wreak havoc on your finances. Economic downturns can lead to salary cuts, reductions, and delays in payments. Before you delve into investing in a bear market, it is better to arm yourself first for a sputtering economy. Create a cushion and build a contingency fund that covers expenses for 6 months. This will save you during emergencies and prevent you from using your retirement savings.
Bear markets are also a good time to reassess your risk appetite. Some investors wait to ride out the bear market before investing. When the market fully recovers, investors often realise that they have missed the bus. The longer you wait, the further you fall behind. So make a staggered entry into the market, but ensure you have enough cash in hand.
To make informed decisions, it is essential to have a financial plan in place. Without a plan, you are likely to make rash decisions during market upheavals.
Short Selling During a Bear Market
Investors are capable of accruing gains during a bear market by taking advantage of short selling. This strategy requires the sale of borrowed shares which are then bought back at lower prices. This strategy is extremely risky and is capable of incurring major losses in the event that events don’t transpire as planned. Short sellers are required to borrow shares from a broker prior to placing a short sell order. The profit and loss acquired by a short seller amounts to the difference that exists between the price at which the aforementioned shares were sold and then bought back and is known as “covered”.
Inverse ETFs and Puts During Bear Markets
Investing during a bear market necessitates discipline and a systematic approach, rather than attempting to forecast precise market bottoms. Bear markets are part of normal market cycles and may present chances for long-term, goal-based investing.
Key practices include:
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Gradual investing: Rather than investing all at once, spreading purchases over time can help lessen the risk of buying at unfavourable price points and may cut the average cost of holdings during volatile periods.
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Diversification of assets: Allocations across shares, bonds, and cash equivalents can assist in managing portfolio risk. Diversification across sectors may help mitigate the effects of concentrated losses.
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Rebalancing: Periodic rebalancing helps preserve the planned asset mix, since stock drops can cause portfolios to drift from their original allocations.
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Time horizon alignment: Investment decisions should reflect individual time horizons and tolerance for temporary swings, as markets frequently rebound before sentiment improves.
Also Read: What are Cash and Cash Equivalents?
Short Selling During a Bear Market
Investors are capable of accruing gains during a bear market by taking advantage of short selling. This strategy requires the sale of borrowed shares, which are then bought back at lower prices. This strategy is extremely risky and is capable of incurring major losses in the event that events don’t transpire as planned.
Short sellers borrow shares from a broker and sell them in the market, aiming to buy them back at a lower price. The profit and loss acquired by a short seller amounts to the difference that exists between the price at which the aforementioned shares were sold and then bought back, and is known as “covered”.
Inverse ETFs and Puts During Bear Markets
With the aid of a Put option, investors and traders alike have the freedom without being tied down with the onus of selling a specific stock at a specified price on or prior to a specified date.
Put options are used in order to speculate on the falling prices of stocks and hedge against these falling prices, such that long-term portfolios can be protected.
Additionally, inverse ETFs can be employed in order to speculate or safeguard portfolios. Inverse ETFs function by changing values in the opposite direction of the index they follow.
Further Tips
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Hold tight: If you believe in any company, then hold on no matter how steeply its stock price falls. You can consider selling if you need cash; you should also reassess your portfolio to check if trading in the company’s shares is prudent. It is better not to jeopardise your goals by liquidating long-term investments.
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Buy stocks: During a bear run, the stock prices of all companies fall. It is considered the best time to invest and buy shares. However, you should buy stocks of good companies which will rise in the future. Rebalance your portfolio and shift focus from growth stocks to value stocks.
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Take a long-term approach: It is unlikely that the stocks you buy will yield returns within a year, as it is difficult to predict how long the bear market will last. Hence, take a long-term approach and buy stocks that you will hold for a longer period.
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Buy dividend stocks: Bear markets are a good time to net companies with a history of high-paying dividends. Dividends are a good way of generating a steady income. It will also allow you to reinvest the money you earn through dividends. However, do not ignore the high-growth companies by looking only at dividend stocks. When prices drop, it is the best time to buy high-growth shares that you have always been eyeing.
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Diversify your portfolio: While bear markets are the best time to buy stocks, they can also be a good opportunity to diversify your portfolio and buy bonds. Bonds are less volatile and will give you a regular cash flow that you can reinvest. Bonds are fixed assets that reduce the amount of risk in your retirement portfolio. The addition of such assets that are not dependent on the market’s rise and fall can increase returns.
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Timing the market: Most investors flee the market and exit their investments during the bear market. Market volatility is a fact, and while the drop creates panic among investors, timing the market is a fool’s errand. The best move during the bear market is to ride through the storm.
Also Read: What are Bonds?
Conclusion
Bear runs do not last forever. While the downward trend can be intimidating, a bear market is often described as a "sale" on the world's greatest companies. Choosing the right stocks is crucial, but maintaining the emotional discipline to stay the course is equally important. By focusing on quality, keeping a healthy cash reserve, and leaning into a long-term perspective, you can transform a period of market anxiety into a strategic advantage for your financial future.
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