Updated: Jan 11, 2021
Majority of people have an irrational fear of bears. And the same fear should apply to bear markets.
Bear markets are the the opposite of a bull market. It refers to a market that experiences price decline over a period of time. An accepted measure of a bear market is a price decline of 20% or higher over a two-month period.
A bear market can either be cyclical, sensitive to the cycle of businesses, or long term. The former is short-term as it lasts for weeks or months while the latter can last for extremely long periods, even decades sometimes. As a result, a bear market is met with negative connotations.
Why Does This Happen?
Because of herd behavior, fear to avoid further losses, and a rush to sell such losses, a period of depressed asset prices can be prolonged. The most famous bear markets occurred during the late 1920’s that arguably led up to the Great Depression. Recently, the recession of 2008 and the market collapse caused by Covid-19 has also drawn comparisons to what happened nearly a century ago. The housing bubble that abruptly burst in 2007 shocked the United States and the rest of the world into a global recession that took years to recover from. Firms on Wall Street such as Bear Stearns (get it, bear market?) and the Lehman Brothers failed to recover due their amounts of worthless assets and large purchasing of mortgages prior to the collapse of the economy.
What Do People Do During Bear Markets?
Oftentimes during bear markets, people will short-sell their assets to make a gain. Short-selling involves selling borrowed shares and then buying them back at a lower price. This is extremely risky because people are then betting that the stock will decrease in price and that there is no limit on the amount of losses for a short-stock.
A traditional investment would be if Cole purchased a stock for $100. The most he can lose financially wise, without accounting for the time and effort spent into purchasing that stock is $100.
However, if the stock he purchases rises up by $200, $500, $1,000, Cole has a great return on his investment. However, a few months later, Cole notices the market is in a bear market and decides to short a stock in order to make a profit. He shorts it at $100, so the most he can ever make is $100. Should the price rise to $1,000 Cole has to pay $1,000 to cover his initial amount of $100.
But let’s say that Cole does make money on his investment. Say he shorts 100 stocks, instead of one this time at a price of $100. However, the price falls and as a result, his shares are covered to $90. Cole receives a profit of $1,000 (100 x $10) since each stock brings in a profit of $10.
So has COVID-19 forced the market to be a bear one?