This article was written by Atul Surana. He is a Certified Financial Planner.
What causes bull and bear markets? They are partly a result of the supply and demand for securities. Investor psychology, government involvement in the economy and changes in economic activity also drive the market up or down. These forces combine to make investors bid higher or lower prices for stocks.
To qualify as a bull or bear market, a market must have been moving in its current direction (by about 20% of its value) for a sustained period. Small, short-term movements lasting days do not qualify; they may only indicate corrections or short-lived movements. Bull and bear markets signify long movements of significant proportion.
There are several well-known bulls and bears in American history. The longest-lived bull market in U.S. history is the one that began about 1991 and is still climbing. Other major bulls occurred in the 1920’s, the late 1960’s and the mid-1980’s. However, they all ended in recessions or market crashes.
The best-known bear market in the U.S. was, of course, the Great Depression. The Dow Jones Industrial Average lost roughly 90 percent of its value during the first three years of this period. There were also numerous others throughout the twentieth century, including those of 1973-74 and 1981-82.
PREDICTING BULL AND BEAR MARKETS
Investors turn to theories and complex calculations to try to figure out in advance when the market will scream upward or tumble downward. In reality, however, no perfect indicator has been found.
In their attempts to predict the market, economists use technical analysis. Technical analysis is the use of market data to analyze individual stocks and the market as a whole. It is based on the ideas that supply and demand determine stock prices and that prices, in turn, also reflect the moods of investors. One tool commonly used in technical analysis is the advance-decline line, which measures the difference between the number of stocks advancing in price and the number declining in price. Each day a net advance is determined by subtracting total declines from total advances. This total, when taken over time, comprises the advance-decline line, which analysts use to forecast market trends.
Generally, the A/D line moves up or down with the Dow. However, economists have noted that when the line declines while the Dow is moving upward, it indicates that the market is probably going to change direction and decline as well.
INVESTING DURING BULL MARKETS
A key to successful investing during a bull market is to take advantage of the rising prices. For most, this means buying securities early, watching them rise in value and then selling them when they reach a high. However, as simple as it sounds, this practice involves timing the market. Since no one knows exactly when the market will begin its climb or reach its peak, virtually no one can time the market perfectly. Investors often attempt to buy securities as they demonstrate a strong and steady rise and sell them as the market begins a strong move downward.
Portfolios with larger percentages of stocks can work well when the market is moving upward. Investors who believe in watching the market will buy and sell accordingly to change their portfolios.
Speculators and risk-takers can fare relatively well in bull markets. They believe they can make profits from rising prices, so they buy stocks, options, futures and currencies they believe will gain value. Growth is what most bull investors seek.
The opposite of all this is true when the market moves downward.
INVESTING DURING BEAR MARKETS
Successful investing in bear markets can involve many different strategies. Some investors try to secure their assets in less volatile securities such as fixed-income bonds or money market securities. Others wait for the downward trend of prices to subside. When it does, they begin buying. Still others seek to take advantage of the falling prices.
When the market goes down, portfolios with a greater percentage of bonds and cash fare well because their returns are fixed. Many financial advisors emphasize the value of fixed income and cash equivalent investments during market downturns.
Another strategy is to simply wait for the downward prices to reverse themselves. Investors who wish to remain invested in stocks may seek out companies in industries that perform well in both bull and bear markets — shares in these companies are called defensive stocks. The food industry, utilities, debt collection and telecommunications are popular defensive stocks. However, there is no guarantee that a defensive stock will perform well during any market period.
Finally, some investors attempt to exploit profits from the downward price movements. One method is to sell at the beginning of a downward turn, when prices are still high. Proponents of this strategy wait for prices to bottom out before reinvesting in the market. However, as simple as it sounds, this process involves the nearly impossible task of timing the market. Another, more complicated way to attempt to profit from falling prices is called selling short.
There are many investment methods that seasoned investment professionals use to take advantage of opportunities during bull or bear markets. Understanding well-founded strategies will help you to improve your chances for superior performance in either market environment.
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