It’s called a bear market when the stock market falls over 20% or more over the course of 2 months of more. The stock market is made up of the bulls and the bears. Bulls try to push price up and the bears try to counterattack by pushing price down.

As I explained in other blog posts, what goes up must come down – similar to a roller coaster. This analogy can be applied to the stock market. A lot of times, the behavior of stocks follows a predictable pattern.

Think about a time 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 dare I say 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. Why is it called a bear market?

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 end result is a plummeting of stock prices, decreased trading activity and low dividend yields. 

Eventually, the downward ride levels out and we see investors coming back in 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 not familiar 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 fondly recall thinking “you can’t be serious, you’re referring to the stock market in terms of four-legged furry wild animals?” What the heck am I getting myself into here?” In fact, the terms are quite clever.

Think back to movies you have watched where a bear attacks; what way 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 opposite of a bear market; confidence is high, stock prices are rising and optimism is the prevailing mood of the investors. Now think of how a bull attacks its prey?

A bull attacks its prey by charging with their horns thrusting upward into the air; and this is where we get the term bull market.

Our trading room discusses safely trading in bear markets.

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 the majority of stocks will be going higher.

Similarly, if you hear someone say the market is “bearish” or “collapsing”, they’re not referring to a specific stock. They mean the whole stock market is losing its value – all stocks together. 

The same is true for specific sectors. Take the pharmaceutical sector for example; when the pharmaceutical sector is weak, all of the other pharmaceutical companies are losing their value as well. 

20% Drop

A 20% drop in a stocks price 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. In fact, the average length of a bear market is 367 days. 

Another key point to realize is that bear markets are accompanied by recessions; where the economy stops growing then contracts. End 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 are behaving with irrational exuberance, then 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 the importance of knowing why is it called a bear market.

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 simply could be an unjustified rise in price. 

What’s more, market corrections tend to last no longer less 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. In total, the average market correction lasted 10 months, with the average bear market lasting approximately 15 months. 

On a positive note, bear markets are typically shorter than bull markets, which surely bodes well for investors.

Conclusion

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.

Having said that, it’s very important you learn how to trade in bear markets. In fact, money can be made in a bear market. This is especially for those who short sell.