Over the years, professional investors around the world have understood the most important rule of trading on the stock market and making money. Experienced investors know how essential it is to buy stocks when there’s a lot of fear in the stock market. While most people sell their shares, professionals are taking advantage of the fear.
What do they do? They buy when there’s fear. When the market is going down, they are the buyers. After a while, when the market is going up, experienced investors are selling. In other words, they are excited when there’s a lot of fear and people are selling.
However, to be able to do this and make money, you have to know if the market is bearish. So, do you want to find out what are the warning signs of a bear market and how you can take advantage of this situation? Let’s continue then.
What is a Bear Market?
In shorts, a bear market is when the market is moving down over a short time – typically two months or more. As the market moves down about 20 percent or more from recent highs, people often start to panic amid widespread pessimism. They get scared about putting money into the stock market.
Typically, bear markets are associated with a general sense of decline in an overall market. On the other hand, the decline can be in an index such as the S&P 500. For example, during the 2007-2009 financial crisis, the S&P 500 index fell 56.8 percent and lasted for about 17 months.
Moreover, history has shown that bear markets lengths may vary. For instance, since 1926, there have been nine bear markets. One of these bear markets lasted three months. On the other hand, the longest one lasted 31 months. In short, bear markets can last for several weeks or several years.
What Causes a Bear Market?
In general, a weak or slowing economy may lead to a bear market. Moreover, factors such as low employment, low income, struggling economic sectors, low productivity, as well as a drop in business profits, are the main bearish market signs.
Further, changes in the tax rate can also lead to a bear market. As consumers play an essential role in the health of the economy, they are also a crucial factor. For instance, if they get scared or lose confidence in their investment, they can lead to the onset of a bear market.
Investors who want to make a profit from a bear market buy quality stocks at low prices. Once the market is going up again, or in other words, during a bull market, these investors will sell the shares. However, they will have to wait until the stocks have regained their value. Let’s see which are the warning signs of an upcoming Bear Market.
Warning Signs of a Coming Bear Market
During a bear market, there are many ways in which investors can make money. For example, short selling, put options as well as inverse ETFs are among these ways. In general, to be successful, you have to monitor the overall health of the economy.
Moreover, investors who want to know whether the next bear market is around the corner can watch out for the following signs.
High-Yield Bond Spreads
You may know it as a credit spread. High-Yield Bond Spreads show the difference in yield on high-yield bonds and a benchmark bond measure like, for example, Treasury bonds. In other words, the high-yield bond spreads show what riskier companies are paying to borrow in comparison to what the government pays.
Why are they important? High-yield bond spreads are good at picking up signs of economic stress at an early stage. Furthermore, during the last two stock market peaks, there was a steady trend higher in high-yield bond spreads, which was a signal for all experienced investors.
Yield Curve Steepness
As we mentioned, you have to monitor the overall health of the economy. However, you have to watch the health of the stock market as well. Typically, the yield curve is one of the best forecasting tools for the peak in the stock market. Moreover, it measures the interest rates paid on a debt of various maturities.
Furthermore, when the yield on long-term government bonds is higher than on short-term debt, then it is safe to safe that the economy is strong. However, the sign investors are looking for is when the yield curve inverts. In other words, when short-term yields surpass the long-term ones.
Moreover, for warning signs of a coming bear market, there are indicators you need to watch
- Monitor Consumer Sentiment
- Consumer Confidence
- A/D line analysis
Phases of a Bear Market
Typically, bear markets have four phases. First, investors can notice an increase in stock prices. This phase is also characterized by high investor sentiment. At the end of this phase, investors begin to drop out of the markets, thus making a profit.
The second phase begins when stock prices fall rapidly. Further, economic indicators start to become below average. Of course, this is the time when investors begin to panic and tend to make the mistake of selling their shares as sentiment starts to fall, which is referred to as capitulation.
In the third phase, speculators enter the market. Moreover, this leads to a rise in some of the stock prices as well as the trading volume.
Last but not least is the fourth phase, where stock prices continue to drop slowly. Once the good news starts circling the media and the internet, investors feel comfortable again and begin to invest, which, on the other hand, leads to a bull market.