Learning Lab: Understanding Bull & Bear Markets
Before we talk about bull and bear markets, it’s important to have a good understanding of how financial markets evolve over time. Economy as a whole and markets in particular always oscillate. No market or asset has been going up or down indefinitely. This is because financial markets are influenced by a lot of factors and some of them will be on opposite sides. Let’s dive into a comprehensive article about market and investor behavior, and the intricate relationship between the two. This blog is not financial advice. You can regard it as a source of inspiration meant to help you make better decisions and ask the right questions yourself.
What Moves the Markets?
First and foremost, any particular asset or market is directly impacted by the millions of people buying or selling at any given time. Actually, it is safe to say that traders and investors actually are THE market. But the evolution of it has way bigger implications. Starting from political decisions and turmoil, all the way to monetary policies, natural hazards or influential people giving various statements, all these factors are at play and will weigh in, more or less, on the behavior of financial markets.
Another important aspect is the fact that people often function on a chain reaction basis. For example – you might not be interested in a certain asset as you don’t think it’ll bring much value. But for a fact, it might happen that left, right and center people are flocking to buy that asset and it is gaining more value by the day. This can change your mind of course as you would like to take advantage of the momentum.
On the contrary, you might be committed to holding onto the assets in your portfolio, determined to pull through downswings no matter what. But the more the markets descend, the more people will reach a stop-loss and start selling. It then starts to cascade into a downward spiral, to a point where you are not willing to take any more losses and will sell out.
Both upward and downward dynamics can be seen in the markets at any given time. Furthermore, the pattern can make sense both on longer timeframes, like a year or more, but also on short term market volatility.
It’s hard to time the markets and predict exactly what is going to happen. But to have at least some idea, it’s important to understand where they are coming from. In other words, investing and trading is a time-dependent process. Several people might buy and sell the same asset roughly in the same month, but depending on the exact timing, some of them might be making profits while others might lose money. This is why it is important to plan your investment long term and be flexible, meaning – to have a wider time frame in mind and also be prepared for several scenarios. One thing all of us have to accept – the markets won’t always work our way.
Bull markets are what every investor wants: prolonged periods of time when more and more people buy into the markets, driving the prices up. Even so, during bull markets there will be people buying at the wrong time and price. To profit from a bull market, you must of course be in the market – meaning – you must already have assets in your portfolio. Though, some people will only feel confident in buying when the markets have been running hot for a while and are at all-time peaks. But just as no bear market lasts forever, no asset will go up indefinitely. When the markets are showcasing record upswings, you can profit by selling what you bought during bear markets at a fraction of the cost. But buying during bull markets can also be profitable because sometimes, crypto assets consistently gain value for months on end. There are several ways one can profit from the huge positive sentiment, and it is strictly related to the buy price:
Sell What You Bought In the Bear Market
If you were inspired enough to acquire assets at a discount during the previous bear market (like smart investors), your portfolio will have the most positive outlook after a prolonged bull market. Ideally, you would sell at market peak, but as nobody can precisely predict it, a good idea is to start cashing in with a DCA method as the markets hover at record peaks.
Take Profits Limit
Let’s consider your investment is now valued 500% more after months of bull market. But all of a sudden, there’s a downturn and you decide to take profits after a certain margin – for instance, if your profits go below 350% – you can decide to sell out and walk away with money. This will still be a very good investment.
Short-Term Bull Run
Imagine the bull market has been active for months now. All this time, you waited on the side to buy at lower prices. But it might be the case that the markets never went as low as you expected. They kept racing up! Now it’s obvious that the public sentiment is strong and more people are buying everyday. Even if you don’t already have any assets in your portfolio, you can still buy during strong bull markets. Of course, you will buy at record prices. But for a fact – people who bought Bitcoin and other crypto at all time highs at the end of 2020, still managed to profit 3x at the all-time highs a year later. Buying during a prolonged bull market can be profitable. Be careful though, as the downswing might not be far away.
Did You Know?
- In the last century, there have been 26 bear markets in total. How about bull markets? There have been 27 bull markets following all declining periods.
- The average bear market period lasted 1.3 years with an average cumulative loss of -38%.
- The average Bull Market period lasted 6.6 years with an average cumulative total return of +339%.
A bear market is when more people are selling than buying, causing a downturn of more than 20%. Bear markets can affect all financial markets (crypto, stocks, commodities, etc.), especially during times of recession or economic crisis, or can be particular only for certain assets, for shorter periods of time.
How to deal with bear markets then? The answer to this is complex in nature but has some simple principles attached to it. While you can’t predict exactly what is going to happen, you might function on an approximate basis:
Dollar-Cost Averaging (DCA)
As you don’t want to lose your investment you might have a stop-loss in place – a lower margin below which you will accept no more loss. This strategy works best when combined with the dollar-cost averaging method. As the markets are down 15% for example, you start selling equal parts of your investment. As the markets go below 20%, the parts you are selling increase in size. If the markets drop below 25%, you cash out all your positions, accepting no further loss and securing any profits.
A good resilience strategy could be to diversify your portfolio in order to have better leverage and more options. Some assets might depreciate more than others, so sometimes a good idea might be to spread your investment across multiple assets so you can better mitigate the risk. Be careful though! Having to deal with a large portfolio during periods of strong volatility is no easy feat. Understand that theory differs from practice and in the middle of fast moving events, only years of experience will ground you in making the best decisions. Don’t overcommit to a portfolio that is too big to handle! Start with something you can manage and work your way up as you gain experience, make profits and acquire more knowledge.
Hold and Wait
The bear market is now in full swing and you did none of the above? Your investment might now be valued at around 33% of the initial price. Not a pretty picture. But having patience can sometimes pay out in the long run. In the 2018 crypto crash, there were a lot of people who did not sell. Some because they were too scared to do it, others because they were confident they acquired good positions that will pay out eventually. A couple of years later the 2021 bull run reached all time highs. Suddenly, people who bought Bitcoin in 2017 were now having their profit multiplied 15 times. Not a bad 3 years return rate – going through a bear market in the process.
No Bear Market Lasts Forever
As previously mentioned, investment is a time dependent process. The 3 scenarios above are good examples of this. By now, we hope you understand the implications of thinking long term. But also, the importance of acting instantly if you feel that is the best decision. The markets favor buyers and sellers alike. In the end, it’s important to take away the idea that no bear market lasts forever. Also – an asset bought during a bear market at low price, will probably earn you back dividends in the long run. When the markets will be moving up again – will you be in a position to profit?
Bull Markets Make You Money, Bear Markets Make You Rich
Experienced investors will know that both bulls and bears make money. More precisely, just like we detailed above, both market periods can be favorable for investment. In time, you will find out that perhaps the best strategy is a mix of all of the above.
An essential thing to keep in mind is that both stocks and crypto have gone up since the beginning of time. With all the highs and lows aside, the crypto market as a whole has gained more and more value in the long run. As for the bear markets, newcomers and inexperienced investors will usually panic and watch from the sidelines, leaving sharp investors with the opportunity to acquire assets at a very favorable price. Ask any pro and you will get the same answer – solid portfolios are built during bear markets. That’s when real value can be found. What kind of an investor are you?
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