Financial markets move in trends. It’s important to understand the differences between these trends to be able to make better investment decisions. How come? Well, different market trends can lead to wildly different market conditions. If you don’t know what the underlying trend is, how are you going to adapt to changing conditions?
A market trend is the overall direction that the market is going. In a bear market, prices are generally declining. Bear markets can be a challenging time to trade or invest in, especially for beginners. In this article, we’ll discuss what a bear market is, state a couple examples for reference, and how to make money from bear market.
What is a Bear Market?
A bear market can be described as a period of declining prices in a financial market. Bear markets can be extremely risky and difficult to trade for inexperienced traders. They can easily lead to great losses and scare investors from ever returning to the financial markets.
When the price starts crashing, many traders rush to exit the markets. They do that to either stay in cash or lock in profits from their long positions. This can quickly result in a domino effect where sellers rushing to the exit leads to even more sellers exiting their positions, and so on. The drop can be amplified even more if the market is highly leveraged. Mass liquidations will have an even more pronounced cascading effect, resulting in a violent sell-off.
Typically, investors are “bearish” in a bear market, meaning that they expect prices to decline. This also means that market sentiment is generally quite low. However, this may not mean that all market participants are in active short positions. This just means that they expect prices to decline and may be looking to position themselves accordingly if the opportunity presents itself.
Bear Market Examples
As we’ve discussed, many investors think that Bitcoin has been in a macro bull trend since it started trading. However, it had quite a brutal bear market contained in that 2017 bull run where Bitcoin moved up to around $20,000. And before the 2018 bear market, Bitcoin experienced an 86% drop in 2014.
Other notable bear market examples come from the stock market. The Great Depression, the 2008 Financial Crisis, or the 2020 stock market crash due to the coronavirus pandemic are all noteworthy examples.
These events have all caused great damage on Wall Street and impacted stock prices across the board. Market indexes such as the Nasdaq 100, the Dow Jones Industrial Average (DJIA), or the S&P 500 index can experience significant price declines during times like these.
How to Make Money from Bear Market
One of the simplest strategies traders can use in a bear market is to stay in cash (or stablecoins). If you’re not comfortable with prices declining, it may be better to simply wait until the market gets out of bear market territory. If there’s an expectation that a new bull market may come at some point in the future, you can take advantage of it when it does. At the same time, if you’re long-term HODLing with an investment time horizon of many years or decades, a bear market isn’t necessarily a direct signal to sell.
When it comes to trading and investing, it’s generally a better idea to trade with the direction of the market trend. This is why another lucrative strategy in bear markets could be to open short positions. This way, when asset prices are going down, traders can profit off the decline. These can be day trades, swing trades, position trades – the main intention is simply to trade in the direction of the trend.
With that said, many contrarian traders will look for “counter-trend” trades, meaning trades that are against the direction of the major trend. In the case of a bear market, this would be entering a long position on a bounce. This move is sometimes called a “bear market rally” or a “dead cat bounce”. These counter-trend price moves can be notoriously volatile, as many traders may jump on the opportunity to long a short-term bounce. However, until the overall bear market is confirmed to be over, the assumption is that the downtrend will resume right after the bounce.
This is why successful traders will take profits (around the recent highs) and exit before the bear trend resumes. Otherwise, they could be stuck in their long position while the bear market continues. As such, it’s important to note that this is a highly risky strategy. Even the most advanced traders can incur significant losses when trying to catch a falling knife.
Closing Thoughts
We’ve discussed what a bear market is, referenced a few examples, and how to make money from bear markets. In summary, the most straightforward strategy is to stay in cash in a bear market – and wait for a safer opportunity to trade. Alternatively, many traders will look for opportunities to build short positions. As we know, it’s wise to follow the direction of the market trend when it comes to trading.
