bear market

What It Is

A bear market is a period of several months or years during which securities prices consistently fall. The term is typically used in reference to the stock market, but it can also describe specific sectors such as real estate, bond or foreign exchange. It is the opposite of a bull market, in which asset prices consistently rise.

How It Works

Identifying and measuring bear markets is both art and science. One common measure says that a bear market exists when at least 80% of all stock prices fall over an extended period. Another measure says that a bear market exists if certain market indexes -- such as the Dow Jones Industrial Average and the S&P 500 -- fall at least -15%. Of course, different market sectors may experience bear markets at different times. The bear market that occurred in the U.S. equity markets from 1929 to 1933 is one of the most famous bear markets in history.

The causes and characteristics of bear markets vary, but most financial theorists agree that economic cycles and investor sentiment both play a role in the creation and momentum of bear markets. In general, a weak or weakening economy -- indicated by low employment, low disposable income, and declining business profits -- ushers in a bear market. The existence of several new trading lows for well-known companies might also indicate that a bear market is occurring. It is important to note that government involvement affects bear markets. Changes in the federal funds rate or in various tax rates can encourage economic expansion or contraction, ultimately leading to bull or bear markets.

Falling investor confidence is perhaps more powerful than any economic indicator, and it also often signals a bear market. When investors believe something is going to happen (a bear market, for example), they tend to take action (selling shares in order to avoid losses from expected price decreases), and these actions can ultimately turn expectations into reality. Although it is a difficult measure to quantify, investor sentiment shows through in mathematical measurements such as the put/call ratio, the advance/decline line, IPO activity and the amount of outstanding margin debt.

Regardless of their exact beginnings and ends, bear markets typically have four phases. In the first phase, prices and investor sentiment are high, but investors are beginning to take profits and exit the market. In the second phase, stock prices begin to fall quickly, trading activity and corporate earnings fall, and positive economic indicators are below average. Investor sentiment also gets more pessimistic and some investors panic. Market indices and many securities reach new trading lows, trading activity continues to decrease, and dividend yields reach historic highs. In the third phase, prices and trading volume increase somewhat as speculators enter the market. In the fourth and final phase, stock prices continue to fall, but they do so at a slower pace. As investors find prices low enough and as they react to good news or positive indicators, bear markets often eventually give way to bull markets.

Why It Matters

Bear markets cost investors money because security prices generally fall across the board. But bear markets don't last forever, and they don't always give advance notice of their arrival. The investor must know when to buy and when to sell to maximize his or her profits. As a result, many investors attempt to "time the market," or gauge when a bear market has begun and when it is likely to end.

Analysts spend thousands of hours trying to mathematically determine what will trigger the next bear market and how long it will last, and technical analysis is especially prevalent in this effort.

For details on the history of the words that describe market trends, read The Quirky And Brutal Origins Of The Terms 'Bear' And 'Bull.'

Source: Investing Answers