Example of Bull Market
Bombay Stock Exchange Index SENSEX (India) was going through a bull market trend for about 5 years from April 2003 to January 2008 as it rose from 2,900 to 21,000 points.
Example of Bear Market
The Wall Street Crash of 1929 was followed by a bear market that wiped off 89% (from 386 to 40) of the Dow Jones Industrial Average's market capitalization by July 1932, designating the commencement of the Great Depression.
Successful stock trading requires a keen insight into the working of the stock market, its mood swings, and various intricacies. One of the basic things about long-term investing is knowing the cyclic trends of the market, such as the bullish and bearish trends. Simply put, the bullish trend is when the stock prices are appreciative, while the bearish trend is when the prices plummet. Let's take a look at some fundamentals.
Bulls and Bears: All in the Name
It is difficult to pinpoint the exact source of the two terms, but historians are of the opinion that the market movements were named after the behavior of the two animals. A bull, when attacking an enemy, thrusts his head upward to inflict maximum damage with the foot-long horns. A bear, on the other hand, strikes with its paws, swiping them down with massive force to lacerate his enemy. This can be juxtaposed to the movement of the market too―a bull thrusting up and a bear striking down. It goes deeper than mere personification though, the bull and the bear are dangerous animals and can cause serious harm to humans. So, investors better be careful. However, to have a better understanding of these market conditions, we must study them individually.
What is a Bull Market?
Let us first understand the meaning of a bull market. A bull market trend means that the sentiment in the stock market is very positive. This is actually due to various reasons.
- Strong and consistent economic growth data is a must for a bull market. There should be an appreciation in the market to the tune of at least 20%.
- The bull market is a period when we see a consistent and steady rise in the prices of stocks of listed companies.
- There is no opposition to the movement of the entire market, and there are more buyers than sellers.
- There is a significant presence of both retail as well as institutional investors in the stock markets in a bull market.
- A lot of delivery-based buying is seen in a bull market which propels it in an upward direction.
Bull Market Cycle
The bull market is characterized by appreciating stock prices and an upward trend in the larger economy in general. It must be remembered that these market trends are actually long-term trends, and there is no bull market for a single trading day. Only when the conditions remain for about a year or more, is the market considered to be in a particular phase. The conditions that give rise to a bullish market are actually quite simple.
- A positive outlook among the consumers results in an increase in spending.
- This causes an increase in the operating profits of the companies listed on the stock exchange.
- A greater profit means better dividends and an appreciation of the share price.
- Better returns mean there is more foreign and domestic investment in the market.
- This results in investor confidence taking a big boost.
- Spending keeps increasing as the investors remain positive about the market, and the bull market is in full swing.
What to Do in a Bull Market?
Holding On to Blue Chips
This means that one must hold on to the stocks of the companies which have been performing well in the recent quarters. Such companies are typically debt-free with consistent profits and a business model which is hedged against market uncertainty by a process of global expansion. Multinationals, such as McDonald's, Exxon, and Walmart are good examples. Such stocks must be held in long positions for sometime to let them take full advantage of the bull run and appreciate its value.
Another important aspect of stock management during a bull run is diversification. Keeping all your eggs in a single basket reduces the full potential of the capital appreciation that is available during such market conditions. Each sector of the economy performs differently during different market cycles. Though they may all show an upward trend, the returns may differ significantly. Retail may show far more growth during a bullish market than a sector, such as crude oil or heavy engineering. It is important to keep a bunch of stocks which take advantage of the economic upswing from different areas in the economy.
Avoid Short Selling
Short selling is the process of selling stocks which are not in current ownership of the seller, with a hope to be able to repurchase them when the prices go down. The concept here is that the repurchase price of the stocks will be less than what they have been sold for, thus making a profit. The seller approaches a lender and borrows stocks against a fee; this he short sells for a profit and returns the stocks to the lender. The lender must receive the stocks of the new valuation. See the following example.
- X company shares are priced at $10 a piece.
- A seller borrows 100 shares in X company and sells them immediately. He gains $1000.
- Subsequently, the stock prices reduce to $5 and he repurchases the stocks making a $500 profit.
Profit Booking at Peak Valuations
Do not be in a hurry to book profits by selling your stocks. The stock market is a long-term game, in both the bullish and bearish phases. It is best to hold on to good stocks during a bull market to be able to gain maximum profit from rising prices. Keep a tab on the pulse of the market, and sell only when you feel a downturn is round the corner.
The Stop-Loss Technique
A stop-loss order is a directive to sell the stocks held when the prices reach a particular market price. This is done to avoid losses in case of plummeting stock prices. The same can be used for rising stock prices. The most common phenomenon during a bull run is the incidence of mass profit booking. This happens when market opinion about the price of a certain stock decides that the valuations have reached their maximum potential. What follows is mass selling, causing a steep decline in stock prices. A stop-loss order helps secure profits in such cases.
A Bundle of Cash
This is true for both bull and bear markets. To be able to successfully invest and cover losses, one must have a good capital base of cash and liquid instruments ready. In a bull market, this cash base helps purchase stocks quickly, and when the trend changes, it buffers your initial investments in case they incur losses.
What is a Bear Market?
It's time to face the bear―easily the more dreaded of the two animals that rule the stock exchange. Here are a few facts about the bear market.
- It is characterized by low earnings, poor financial results, stagnant economic growth, and lack of confidence in stocks among investors.
- A lot of short positions are seen being created in the market. These shorts may be cut for a few occasions, but ultimately, due to lack of buying by big players, the stock markets continue to slide down.
- Poor performance of foreign stock markets is also a reason for a bear market.
- A bear market will reduce stock prices of even the most valuable companies if they don't handle their core competencies well.
- The pricier stocks come down the quickest as their value erodes faster.
What to Do in a Bear Market?
Although a bear market, by far, is a loss-making time for everyone, you can still hedge your bets and ride it out by being sensible about investing. If one is adventurous, one can even make a profit out of buying cheap during such phases and selling when the market rebounds. Yet, for the average investor, it will be prudent to observe certain simple guidelines.
Timing the Bear's Charge
It is difficult to gage the behavior of the stock market; even experienced campaigners have problems doing it. For an individual investor, developing that sixth sense of investing can be the biggest challenge. Yet, there are several pointers which herald the coming of a bearish phase in the market.
- The bullish phase ends with a huge rise in prices of stocks, what many term absurd. This tends to overvalue stocks to many times their actual value.
- Interest rates in the economy keep rising, along with other metrics, such as inflation.
- The most telling sign is a sharp fall in prices, mostly thought to be a one-off event in the rush to book profits.
- Another sign is a sudden and dramatic change in market opinion, leading to indiscriminate selling.
Go Short on Weak Stocks
Just like staying in long positions on strong stocks during a bull run, when the bear comes around, it is good to get rid of stocks of companies not doing very well. The logic is that they will incur further losses due to the negative sentiments in the economy, and the stock prices will further reduce. It is best to trim away the weak stocks from your portfolio.
Riding it Out
A theory for bear phase investing is to hold the stocks one has and ride out the storm. This is based on the logic that the stock market gives positive returns in the long run, and buying and selling through the ups and downs of the market will only erode the long-term capital gains. This can be a good strategy when the bear run is short, like the market crash of 1987. There is, however, a problem with this theory. If one does not have a good capital base and is investing for short-run profits, this is an absolute no-no. The loss in stock prices may be severe, and even when the boom returns, they may not rise back to their original levels.
The Escape Artist
Bear markets can be tackled in another way too―selling what you have and moving into the cash investment category. Keep all you money in the bank and staying away from the stock markets until it recovers enough to be considered safe. However, this is playing it too safe and not taking advantages of the opportunities a bear market brings with it.
Another way to remain invested in the market and still make profits later on is buying during the bearish phase. Now, this may sound illogical, but one must be patient with the stock market to be able to make money out of it. The concept of dollar-cost averaging is the principle behind buying low and selling high. It gives a better return for every dollar invested, when the markets rebound. One of the world's greatest financiers Nathan Rothschild once said, "Buy on the sound of cannons, sell on the sound of trumpets." He meant that one should buy bonds and stocks during times of war, when the prices are low and sell them when there is peace, as the prices are bound to rise, with better future prospects.
It is never easy to compare the two phases of the stock market. Like the animals they are named after, both bear and bull markets are diametrically opposite to each other, and knowing the pulse of each is difficult. However, one must understand that these phases are cyclical, they are bound to happen sooner or later, and it's best not be carried away by market sentiment. Rushing to sell prime stocks during a bull run is one of the most common causes of a crash and a return of the bearish sentiment. Similarly, frenetic buying during the bearish phase may push up prices and result in a short bull run. The indicators of these cyclical phases are best understood when they are at the macroeconomic level and not at the day trading sessions of the exchange. A thorough analysis of the stock portfolio, company policy, and investment strategy along with the government policies for the fiscal are necessary before one can make an informed judgment about these market trends.