The Wall Street Journal and other financial media outlets often use +/- 20% threshold as a rule of thumb tolabelbull markets or bear markets to market uptrends and downtrends. This way, a new bear markethas begun when an index or other security falls 20% or more away from its peak or trough. Likewise, we have entered a bull market when prices rise 20% or more from a bottom.
This heuristic approach can produce some controversy at times because a financial instrumentthatsells offfrom $20 to $1 in abear marketwill then subsequently be said to technically entera bull market whenit proceeds to gain just 20 cents off of its low, liftingthe instrument to $1.20—marking a 20% rally! So how can we be certain if we're in a bull or bear market? Here we take a closer look.
Key Takeaways
- Bull markets are typically designated by media outlets as a rise of 20% or more from a near-term low.
- Likewise, bear markets are called when an asset falls by 20% from its high.
- However, these heuristics don't always make sense in practical terms.
- Calling a bull or bear market often requires a greater degree of judgment, as well as considering the condition of the broader economy and market psychology.
Defining Bull and Bear Markets
In its simplest definition, rising pricessignify a bull marketwhile falling prices signify a bearmarket. With this in mind, you might think it would be easy to determine what type of market we're grinding through at any point in time. However, it's not as easy as it looksbecause bull-bear observations depend on the timeframes being examined. For example, an investor looking at a 5-year price chart will form a different opinion about the marketthan a trader looking at a 1-month price chart.
Let'ssay the stock market has been risingfor the last two years, allowing aninvestorto argue that it's engaged in a bull market. However, the market has also been pulling backfor the last three months. Anotherinvestorcould nowargue that it'stopped out and entered anew bear market.In sum, the first argument arises from looking at two years of data while the secondarises from looking atthree months of data. In truth, both points of view may be correct, depending on the viewer's particular interests and objectives.
Bear Market Phases
Unlike bull markets, which are usually defined by a prolonged market rally, bear markets usually have four distinct phases to look out for:
- The first phase is characterized by high prices and highinvestor sentiment. Towards the end of this phase, investors begin to drop out of the markets and take in profits.
- In the second phase, stock prices begin to fall sharply, trading activity and corporate profits begin to drop, and economic indicators that may have once been positive, start to become below average. Some investors begin to panic as sentiment starts to fall. This is referred to ascapitulation.
- The third phase showsspeculatorsstart to enter the market, consequently raising some prices and trading volume.
- In the fourth and last phase, stock prices continue to drop, but slowly. As low prices and good news starts to attract investors again, bear markets start to lead to bull markets.
Quantitative methods to detect bull/bear markets rely on technical analysis concepts. Investopedia's Technical Analysis Course will show you how to identify technical patterns and indicators and apply them to make money in bull andbear markets.
Time-Frame Matters
In reality, markets form trends in all time frames, from 1-minute to monthly and yearly views. As a result, bull and bear market definitions arerelativerather than absolute, mostlydependenton the holding period for an investment or position intended to take advantageof the trend. In this scheme, day traders attempt to profit from bull markets that may last less than an hour while investors applya more traditional approach, holdingpositionsthrough bull marketsthat can last a decade or more.
11 years
The longest bull market in modern history—from the bottom of the 2008–09 financial crisis through March of 2020, when U.S. markets entered into a bear market as a result of the rapid global spread of the coronavirus pandemic.
The Economy Matters
Bull and bear markets often coincide with the economic cycle, which consists of four phases: expansion, peak, contraction andtrough. The onset of a bull market is often a leading indicator of economic expansion. Because public sentiment about future economic conditions drives stock prices, the market frequently rises even before broader economic measures—such as gross domestic product (GDP) growth—begin to tick up. Likewise, bear markets usually set in before economic contraction takes hold. A look back at a typical U.S. recession reveals a falling stock market several months ahead of GDP decline.
Investor Psychology
Because the market's behavior is impacted and determined by how individuals perceive that behavior, investor psychology and sentiment affect whether the market will rise or fall. Stock market performance and investor psychology are mutually dependent. In a bull market, investorswillingly participatein the hope of obtaining a profit.
During a bear market,market sentiment is negative as investors begin to move their money out of equities and into fixed-incomesecurities, and wait fora positive move in the stock market. In sum, the decline in stock market prices shakes investor confidence, which causes investors to keep their money out of the market—which, in turn, causes a general price decline as outflow increases.
The Bottom Line
There'sno perfect way to label a bull or bear market. It'seasier to focus on specifictime frames or to consider the sequence of peaks and valleys on the price chart. Charles Dow applied this methodwith his classic Dow Theory, stating that higher highs and higher lows describe anuptrend (bull market) while lower highs and lower lows describe a downtrend (bear market). He tookthis examination one step further, advising that bull andbear markets aren't "confirmed" untilmajor benchmarks—the Dow Industrial and Railroad Averages in his era—make new highs or new lows in tandem.
