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What is Bear Market? 4 Signs of Bear Market and Investment Strategies

December 28, 2020 03:05

In the international financial market, bull and bear markets, which represent upward and downward market trends respectively, are used to describe the overall performance of the financial market. By definition, a bull market is one in which the price of financial products rises by more than 20% or more from a one-year low, which is also called a long market. A bear market is one in which the price of financial products has fallen by at least 20% or more from a one-year high. These terms are also applicable to the evaluation of the trend of various financial assets.

This article will explain the common signs of a bear market and the phenomenon of a bear market rebound, and give advice on bear market investment strategy.

Four Signs of a Bear Market

In the international financial market, the price of financial products, by theory, would increase slowly in the long run, so investors often lack the experience of dealing with the bear market, and they could be at a loss when the bear market comes. The following are four common signs of bear market occurrence, which can be used as a reference for investors.

Bear market sign 1: Black Swan event

A black swan event is an extremely rare event whose probability of occurrence is very difficult or even unable to be predicted. It usually comes as a surprise unexpected and has a significant impact, which can set off a chain reaction of negative reactions or overturn the existing behavior patterns of the market. The black Swan event has an extensive and uncontrollable impact. Samples of black swan events include the collapse of the investment bank Lehman Brothers in 2008, the cancellation of the exchange rate floor of Euro/Swiss Franc by the Swiss National Bank in 2015, and the COVID-19 pandemic, and the negative oil price in 2020. Unpredictable events in the market can cause panic among investors, trigger selling pressure in the financial market, and lead to an avalanche of price declines.

Bear market sign 2: over-optimistic investors

The traditional typical bear market comes from the irrational financial environment. Investors are so intoxicated with the future prospects that they ignore the risks in the market and put most. Greedy investors may even expand their credit loans unchecked to chase the bull market, absolutely ignorant of market risks and the possibility of bubble burst. Asset prices are usually so overvalued by this time that huge correction pressures are brewing.

Bear market sign 3: Unexpected recession in economic data

In general, investors’ expectations of the future are reflected in the financial markets before they actually happen, so the financial markets themselves are leading indicators. Investment markets are bets on expectations, so financial products always stay ahead of the market. But, bear markets tend to follow when actual or published data turn out to be worse than expected, especially when individual data turn sharply out of line.

Bear market sign 4: the rise in traditional safe haven asset

Treasury yields in international financial markets are acknowledged as the benchmark interest rate of the mark.  If the yield curve of US Treasury bonds flattened, or the yield of long-term bonds is lower than that of short-term bonds (the bond interest curve is inverted), it shows that investors have expected that the economy will be weak in the future, money will flow into the bond market for hedging, and high-risk assets will depreciate.

In addition to U.S. Treasuries, gold is another way to avoid market risks. Investors often choose to move money into the gold market as a safe haven in the face of uncertainties, which in turn drives up the price of gold and indicates that a bear market is coming.

What is a bear market rebound?

Bear market rebound refers to the phenomenon of short-term recovery in a downward trend, sometimes due to the rapid falling speed and bargain hunting. The temporary recovery usually won’t be able to reverse the declining trend, and the market will continue to decline after the rebound.

Even in a bear market, the price of financial products do not fall in a straight line, and the downward trend is always mixed with the rebound of the market, which may or may not be accompanied by good news. The principle of the rebound is that the fiercer the fall, the faster the rebound; the deeper the fall, the higher the rebound.

If it is a slow fall, the rebound is often weak, lack of opportunities to participate, but in the retaliatory rebound and oversold bounce, there may be space for short-term profit.

The golden ratio and the pattern theory are the two most commonly used instruments for investors to make a profit in a bear market. The golden ratio is used to predict the extent of a rebound during the price cycle of financial products. The three major indexes are 0.618, 0.5, and 0.382, among which 0.382 is the normal range, i.e. the rebound would be 38.2% of the decline. In addition, investors can draw a graph using the price trend to predict the future direction. Generally, investors would also use auxiliary technical indicators, such as MA (Moving Average),  stochastic oscillator, RSI index, MACD index, Bollinger bands, etc., to enhance the sensitivity and accuracy of market prediction.

Bear Market rebound 0.382

In the rebounding market, many investors often mistakenly believe that the bear market is over and rush in, but they do not know the rebound is just the beginning of a new wave of declines. So, in a bear market, the upward trend may last a day or a few days. Before the bottom is confirmed, it is still in the bear market, and Investors can be trapped if they are not careful enough.

Bear market investment strategies

Investment strategy 1: reduce holdings of risky assets and increase holdings of safe assets

When the bear market comes, the financial products with higher returns are generally the first to bear the brunt. At this time, investors can convert the high-yielding financial assets held in their hands, such as stocks, commodities, and high-yielding bonds, into low-yielding financial assets, or even cash, to construct a new investment portfolio and reduce risks. Foreign currencies such as the US dollar, Japanese yen, Swiss franc, etc., all have the characteristics of risk aversion, while gold and US treasuries are traditional safe-haven assets.

Investment strategy 2: establish a hedge position to avoid market risk

Hedging refers to the behavior of avoiding losses caused by price changes by using other markets and financial derivatives. Investors can evaluate the total value of financial assets held,  and choose the appropriate financial products such as options, futures, and inverse ETF to establish a comprehensive hedging strategy, and avoid huge losses caused by the decline of the bear market.

CFD (contract for difference): An emerging investment tool in bear market

A contract for Difference (CFD) is an emerging financial derivative product whose trading process does not involve physical delivery, but only a settlement of the price difference. CDF is a very suitable investment tool to deal with the bear market as it uses margin trading and supports two-way trading (both long and short). CFD covers a wide range of products, such as forex, raw materials, gold, crude oil, country indices, stocks, etc. According to the financial assets held by the investor, the investor can convert the CFD of equivalent value and construct an opposite position to offset the losses caused by the decline of the bear market. In addition, when the market fluctuates violently, investors can also rely on the negative balance protection mechanism provided by brokers to avoid the possibility of excess losses.

Note: Negative balance protection: An investor would not lose more money than he or she has deposited with a broker. If a loss on a leveraged position deteriorates rapidly, the client only has to take a loss on the principal of the account, and the broker generally promises not to recover the debt.


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What is Bear Market? 4 Signs & Investment Strategies


Risk Warning: The above content is for reference only and does not represent ZFX’s position. ZFX does not assume any form of loss caused by any trading operations conducted in accordance with this article. Please be firm in your thinking and do the corresponding risk control.

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