What Does Bearish Mean in Trading?

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Introduction

A market, asset, or financial instrument is said to be bearish if you think it will move in a downward direction. The opposite of being bullish, which implies that you believe the market is going up, is being bearish.

Since market mood is a significant determinant of how the financial markets move, it is crucial for traders to be able to spot bearish trends. A market often experiences a price decline when the negative pressure outweighs the bullish push.

As a result, a market that has seen its price fall steadily over time is referred to as a bear market. Trading can be profitable and risk-limited by recognising when a bear market is beginning or ending.

Bearish traders aim to profit from a market's slide because they predict that it will soon decline in value. This puts them in competition with bulls, who will purchase a market in the hope of making a profit.

What Is a Bear Market?

A large and ongoing downward trend in the stock market is referred to as a bear market. Stock markets are said to be in a bear market when they decline by 20% or more since a specific moment. According to tradition, the 20% reduction must happen gradually over a minimum of two months. A bear market may not necessarily be defined as a big but abrupt decline in the stock market.

A 10% loss in the stock market is considered a market correction, while a 20% decline is considered a bear market. A correction or bear market can frequently be started by deteriorating economic conditions, worries about valuations, or other factors that make many investors pessimistic.

Bear markets could last for extended periods of time. The 61-month period from March 1937 to April 1942 marked the lengthiest U.S. bear market. There was a 55% drop.

What Is a Bear Investor?

Investors who are bearish are often referred to as bears. Bears predict a decrease in securities prices as a result of fundamental changes, excessive valuations, or technical factors. Short positions can be taken by bearish investors who wish to profit from price declines and take advantage of downturns.

With a short position, an investor sells shares to another investor at market value with the goal of later purchasing it at a lesser cost. The bear anticipates a decline in the stock. The danger here is that the short position will lose value if the stock increases. The investor might have to purchase the stock at a price over what they originally sold it for, incurring losses.

Bearish investors may try to make money by employing an options strategy known as a bear spread. The tactic is purchasing a put option with a certain exercise price and then selling a different put option on the same asset with a lower exercise price.

Some bearish investors simply have a pessimistic outlook on the markets rather than betting money on the price of securities falling.

Taking a Bearish Position

Many traders will short sell in order to take a bearish position. When an asset's price drops, short-selling is a type of trading that results in a profit.

In the past, if you wanted to sell a stock short, for instance, you would borrow some from your broker and sell it right away at the going rate. When the stock's price drops, you would then buy it and sell it back to your broker, keeping the profit from the price difference.

However, because derivatives can be used to buy and sell a wide range of markets, such as spread betting and CFDs, they have made the practise of short-selling much more accessible.

There are numerous additional strategies to try and make money from declining markets. Inverse ETFs, for instance, are intended to counteract any price changes in their benchmark index.

Understanding Bear Markets

Stock prices often reflect future expectations of a company's cash flows and earnings. Stock prices might fall as growth prospects deteriorate and expectations are shattered. Fear, herd behaviour, and a hurry to protect downside losses can all lead to lengthy periods of low asset prices.

According to one definition, markets are in bear territory when stocks have fallen at least 20% from their peak. However, 20% is an artificial figure, just as a 10% drop is an arbitrary baseline for a correction. A bear market is also defined as when investors are more risk-averse than risk-seeking. This type of bear market can linger for months or years as investors avoid risky investments in favour of safe bets.

A weak or lagging or sluggish economy, collapsing market bubbles, pandemics, wars, geopolitical crises, and significant paradigm shifts in the economy, such as changing to an internet economy, are all elements that may create a bear market.

Low employment, low discretionary income, low productivity, and a reduction in corporate earnings are all symptoms of a weak or deteriorating economy. Furthermore, any government involvement in the economy can precipitate a bear market.

Changes in the tax rate or the federal funds rate, for example, can cause a bear market. Similarly, a decline in investor confidence may indicate the start of a bear market. When investors fear that something bad is about to happen, they will take action, in this case, selling off shares to avoid losses.

Bear markets can persist for years or just a few weeks. A secular bear market can run anywhere from 10 to 20 years and is distinguished by below-average long-term performance. Within secular bear markets, stocks or indexes may rebound for a time, but the gains are not sustainable, and prices retreat to lower levels. In contrast, a cyclical bear market might run anywhere from a few weeks to many months.

Bearish Stock Patterns

To detect bearish stocks or market movements, investors might search for certain technical signals. Bearish stock patterns can be useful for investors, but they are not always indicative of a bear trend. Five common bear chart patterns that investors can learn to use in their technical analysis of stocks are:

  • Bear flag - A quick decline in the stock price (flag pole) is followed by trading in the flag with equally spaced highs and lows. For instance, a stock may fall from $10 to $8 a share and then trade between $8 and $8.25 for a period of time. The stock is predicted to decrease similarly to the first flag pole at the end of the bear flag.
  • Double top - At the end of a bull trend, this pattern frequently resembles an M. It signals the conclusion of the uptrend with a peak, followed by a valley, and then another peak that is close to or equal to the high point. When the stock falls below the bottom price between the two peaks, it is deemed bearish.
  • Head-and-shoulders - A design with three tops, the centre top being the tallest and resembling the head. The neckline reflects the trend's support, and if the stock falls below it, it is predicted to continue to fall.
  • Descending triangle - This is a triangle with diminishing highs and the same level of resistance. When the stock falls below the resistance level, it is usually a sell indication.
  • Bearish engulfing candle - When the body of one trading session engulfs the body of a preceding session. This signifies that the new day's open is higher than the previous day, while the close is lower.

Phases of a Bear Market

There are four different phases in a bear market:

  • The first phase is distinguished by high pricing and strong investor sentiment. Towards the end of this period, investors begin to exit the markets and take winnings.
  • In the second phase, stock prices begin to decline significantly, trading activity and corporate profits begin to fall, and previously optimistic economic indicators begin to fall below average. As sentiment begins to deteriorate, some investors begin to panic. This is known as capitulation.
  • In the third phase, speculators begin to enter the market, boosting some prices and trading volume.
  • Stock prices continue to fall slowly in the fourth and final phase. As low prices and positive news begin to entice investors again, bear markets begin to give way to bull markets.

Notable Bear Markets in History

In October 2007, the stock market was taken off guard by the escalating housing mortgage default crisis. On October 9, 2007, the S&P 500 reached a high of 1,565.15. It had fallen to 682.55 on March 5, 2009, as the scope and implications of housing mortgage defaults on the entire economy became obvious. On December 24, 2018, the major market indexes in the United States were once again approaching bear market territory, falling just short of a 20% decline.

The Dow Jones Industrial Average most recently entered a bear market on March 11, 2020, and the S&P 500 entered a bear market on March 12, 2020. This follows the index's longest bull market on record, which began in March 2009.

The outbreak of the COVID-19 pandemic, which brought mass lockdowns and the prospect of reduced consumer demand, drove down stock prices. During this time, the Dow Jones plummeted precipitously from near-30,000 all-time highs to lows of 19,000 in a matter of weeks. Between February 19 and March 23, the S&P 500 fell 34%.

Pros and Cons of Bearish

PROS

Relative market excesses are unwound, and overleveraged weak traders are forced to liquidate, which strengthens the market
Bargains can be found if there is cash on hand

CONS

Most investors are frozen by the falling prices and sell at the worst possible time
In the economy the leverage in stock causes dislocations as it unwound.
Loss of jobs
Loss of various assets
Higher inflation
Margin pressures intensify
 

Conclusion

Overall, investors that are bearish have a negative outlook on certain stocks or the market as a whole. They might invest less in equities in their portfolio, concentrate on more defensive securities, or place wagers on declining price fluctuations.

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