If you’re a long-term investor, then at some point, you’ll probably experience a bear market, often starting with a stock market crash. It’s when your investments plunge in value and don’t recover for a while. There’s often speculation on when the next bear market will take place, but the truth is that no one knows. Experts estimate that they actually take place as often as once every 3 years on average.
In this guide, we take a look at everything you need to know about bear markets. We also answer common questions such as, “What’s the difference between a bear market and a correction?” and “Can you make money in a bear market?”.
What is a bear market?
A bear market is when the stock market drops significantly in price and doesn’t bounce back for at least 2 months. It often starts with a stock market crash when share prices plunge quickly over a few days or hours.
The exact definition of a bear market varies, but most experts agree that it’s when stock market prices dip by 20%. This is caused by a mixture of factors including investor pessimism, an expectation of a global recession and other economic uncertainty.
The opposite of a bear market is a bull market. That happens when stock market prices have been rising for a sustained period.
How do bear markets work?
Bear markets can result in a negative spiral where bad news about the economy leads to investors losing confidence. This loss in confidence leads many investors to sell their investments and causes fewer investors to buy shares. A large-scale share sell-off takes place and that causes more investors to lose confidence. Share prices fall even further, resulting in a downward spiral in share prices.
Share prices are often extremely volatile during a bear market. No one knows whether prices will continue to fall or start bouncing back. This means that share prices can yo-yo up and down as confidence in the market changes from day to day.
What’s the difference between a bear market and a correction?
A bear market is different from a correction. A correction is a short-term stock market trend of under 2 months. In contrast, a bear market is when share prices are depressed for more than 2 months.
When the stock market crashes, there is often lots of speculation about whether there will be a short-term correction or a long-term bear market. This is often not clear for a while and depends on the economic factors behind the crash. If the plunge in prices is caused by something temporary, then stock markets may recover quickly. If the crash reflects longer term economic trends, then there may be a longer period of lower share prices. The problem is that no one knows the future and so it is very difficult to predict if a stock market crash will turn into a long-term bear market or a short-term price correction.
Bear market case studies
In 2008, the FTSE 100 plunged in value by 31%. There was a worldwide financial crisis and stock markets dropped in value around the world. The crisis was mainly due to banking problems and widespread lending to borrowers who couldn’t repay their loans.
The 2008 crisis led to a long-term recession and it took until 2013 for the FTSE 100 to reach its pre-2008 value.
More recently, in March 2020, the stock market crashed as the full scale of the COVID-19 pandemic became clear. Problems were exacerbated by falling oil prices in Russia and the Middle East. The FTSE 100 index plunged 25% in March 2020. By January 2021, share prices had recovered to January 2020 levels as many economies started to bounce back.
What are the phases of a bear market?
Bear markets often have 4 different phases as follows:
Pre-bear market: There is usually a period of high share prices. However, towards the end of this phase, investors start selling their shares to cash in their profits.
Capitulation: This is when the bear market starts. Share prices fall sharply, many companies see a drop in profits and there are indications of wider economic problems. Some investors panic and start to sell their shares.
Speculation: Prices often bounce back slightly as speculative investors buy shares at cheaper prices.
Slow falling prices: Share prices continue to drop, but this time more slowly. The market stays in the doldrums until good economic news starts to attract investors.
Can you predict a bear market?
Predicting the stock market is a mug’s game and even the experts often get it wrong. That’s because stock market prices are largely based on investor confidence. It’s possible for investor confidence to change very quickly as new economic factors emerge in the news. Also somewhat random factors can contribute towards a share sell-off. For example, many experts think that computer-generated automatic selling contributed to the stock market crisis in 2008.
Can you make money in a bear market?
It is possible to make money in a bear market because long-term investors can buy stocks at a cheaper price than normal. This means they can make money by waiting for the stocks to rise again in value.
However, bear markets can be a risky time to buy stocks and shares as prices are extremely volatile. It’s hard to predict the bottom of a bear market and sometimes share prices remain depressed for a long time.
Does a bear market mean I will lose my money?
It is possible to lose money if you sell your investments during a bear market. However, if you can afford to hold onto your investments, then there’s a good chance they will bounce back in value. Historically, stock market investments tend to grow in price in the long run.
Investing in stocks and shares can be a roller-coaster ride. Sometimes your investments will climb in value, but sometimes the value can plummet. Unless you need your money straight away, it usually makes sense to sit tight and try not to panic during a bear market. Selling when the stock prices are low can mean that you crystallise your losses. In contrast, if you hold onto your investments, they will probably regain their value in a few months or years.
Bottom line
Stock market crashes and bear markets often cause investors to panic. But selling when stock market prices are low could mean you lose out because you’ll be selling up when stock prices are cheap.
If you’re a long-term investor and you can afford to hold onto your investments, then it’s often a good idea to sit out a bear market. Historically, prices usually recover within a few years and stock markets usually grow in value in the long run. In fact, £10,000 invested in the FTSE 100 in 1984 would now be worth £74,530. That’s not a bad return for your investment and the gains are despite several bear markets along the way.
Frequently asked questions
Stock markets are naturally volatile as share prices depend on investor confidence and other economic factors. Bear markets happen on average every 3 years, and unfortunately, they are an inevitable part of investing. They can cause some investors to panic and sell their shares when prices are low, or they can also put people off investing in the stock market. It’s a shame because the stock market tends to outperform cash or bond investments over time.
There is no set definition of a bear market; however, many experts agree that it is when share prices drop by over 20% and that price reduction is sustained for at least 2 months.
There are various ways to make money during a bear market. However, they are not for the fainthearted and can be extremely risky.
One of the most common trading options for making money is by using short positions. This works by reversing the normal order of buying and selling shares. Investors sell a share first and then buy it later, hopefully at a cheaper price. To cover the gap they borrow shares from their investment broker. When they buy the stock back, they can return it to the lender.
Taking short positions comes with considerable risk as you are committed to buying the stocks even if prices go up instead of down. Investors also incur extra fees for borrowing the stocks from their broker.
Bonds and gilts are usually more resilient to significant falls in prices and they may even go up in value during a bear market. This is because they are often considered to be a safe haven for investors during a recession. When investors sell their shares and invest in bonds, this often causes prices to rise.
The length of a bear market depends on the underlying reasons for the stock market crash and how long it takes for investors to regain confidence. The 2020 bear market was caused by the coronavirus pandemic and was fairly short-lived. Share prices recovered by the beginning of 2021 once investors saw that economies were bouncing back.
All investing should be regarded as longer term. The value of your investments can go up and down, and you may get back less than you invest. Past performance is no guarantee of future results. If you’re not sure which investments are right for you, please seek out a financial adviser. Capital at risk.
Alice Guy is a Suffolk-based finance writer, a busy mum of 4 older kids and a self-confessed personal finance geek. She trained as a chartered accountant with KPMG London before working for Tesco Plc as a business analyst. She loves to write about budgeting, saving, investing and building wealth. See full bio
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