As a complement to our last article (Understanding bull markets), today we are going to discuss bearish markets, their definition, and the ways to operate with this type of market.
What is a bear market?
Financial markets can be divided according to the trend of the prices of the assets that they comprise. Bullish, bearish, or static.
A bear market is one in which there is evidence of a prolonged decline in the prices of the assets that comprise it. The name “bear” refers to the movement a bear makes when attacking with its claws from top to bottom. This type of market can last for months or even years.
How to identify a bear market?
One of the main signs that a market is going down is a loss of investor confidence and a general sense of pessimism, resulting in a gradual decline in demand. Increased unemployment, threats of war, political tensions or a pandemic are some of the factors due to which these markets can appear.
A market is considered to be in a bear market when it shows a fall in security prices of at least 20% from its last peak.
Signs of bear markets
Aside from falling prices for a long period of time, there are other signs that a market is entering a downtrend:
- Stock prices in an industry sector begin to decline
- Increased supply of such assets and decreased demand.
- A deflation occurs, due to the decrease in spending in the economy of a region.
- The profits of the companies decrease.
- Rising unemployment levels and cutbacks in research and development
- Catastrophes, wars, pandemics
Difference Between a Bear Market and an Economic Recession
It is true that on many occasions, bear markets coincide with an economic recession, however, not 100% of these markets occur with a recession. A bear market shows a downward trend in the price of assets in a market as a result of low confidence or negative investor sentiment, however, said mistrust may be caused by a particular event; while the economic recession is observed through the decrease in the economic activity of a country, mainly by analyzing the changes in GDP (gross domestic product).
Bear Markets in Online Trading
Although it is true that a bear market or an economic recession can affect some part of the population, it is not negative for trading operations. Online trading allows you to trade short and long. (Going short is betting that the price of an asset will go down; going long is betting that the price of the asset will go up.) Therefore these markets represent lucrative investment opportunities in the short term.
In Trading, CFDs are the ideal investment vehicle to invest in bear markets.
As you may already know, CFDs are contracts that allow the investor to speculate on the price of an asset. These contracts are entered into between the broker and the investor, where both agree to pay the difference between the purchase/sale or sale/purchase price.
We believe that it is one of the best alternatives, since with them you can take advantage of the volatility of the market in the short term. Although it is true that prices go down in these types of markets, they never do so constantly, they go up and down, but they go down more than they go up.
Bear markets are commonly used in trading as hedging positions. Hedging is an action that is used for those positions with a negative correlation to the main position.
Markets are said to be correlated when the same economic event affects the price of assets. There is a positive correlation when said event causes the prices of one or several markets to rise; There is a negative correlation, when said event causes the prices of one asset to rise and the other to fall proportionally.
So in trading, opening hedge positions is a kind of insurance, where the investor can redeem profits when the market goes against him in the main positions.
Example of a bear market
An investor shorts 100 shares of a company for $50. The price falls and the shares are covered by 40 euros. The investor makes a profit of 10 euros x 100 = 1,000 euros. If the stock suddenly trades at a higher price, the investor is forced to buy back the shares at a higher price. Therefore, the losses can be considerable.
You can prepare for a bear market by reducing the risk in your investment portfolio. For example, you can reduce the number of growth stocks you own. He can also select bonds or underlying funds that tend to perform better in a bear market.
Consider, for example, gold funds or sector funds that focus on the healthcare sector and the consumer staples sector.