What’s a Bearish Market and Why Should I Care?

Have you ever heard an investor or financial expert call a market bearish? Investors can be funny sometimes. They love data and numbers and working with complex concepts. Yet, there are plenty of rather playful names in the investing world, with bear and bull markets being among them.

A so-called bear market is a market that is trending downwards and is often suffering from a lot of turbulence. More or less, this is a bearish market definition. In January and February of 2016, the world was hit by a global “bearish market” with many indices sinking. Why? China’s debt problem, among other issues, was causing a host of problems.

Investors panicked and many started to sell. When more investors are selling than buying, stock prices tend to drop. So with newspapers filled with negative headlines and analysts from around the world declaring doom, many investors got cold feet and sold off. Luckily, the bear market passed and the so-called bull market returned. Of course, bear markets will make an appearance again in the future. The question is when.

By the way, a bull market is the exact opposite of a bear market. A bull market is one that is rising and trending upwards, and usually is accompanied by a lot of optimism. When bull markets rule the day, you as an investor want to buy, when markets are turning bearish, you want to consider selling.

No one is sure where the bearish meaning originated. The same is true of the bull market definition. There are plenty of theories, of course. Some people believe that bear markets get their name because bears often swipe downward with their massive paws. Bulls, on the other hand, tend to charge forward and then strike upwards with their sharp horns. This theory makes a lot of sense, but don’t quote it as fact.

What we do know is that when markets are bearish, they’re on the decline. And when they are bullish, they are on the rise. Luckily, for investors you can make money off of both types of markets.

Making money off of a bearish market

Wait a minute. Bear markets are markets that are on the decline. How can you make money when stocks are losing value? First, there is a way to make money off of dropping stock prices. Through a process called short-selling, you can actually borrow stocks from a brokerage, sell them, and then repay the stocks after stock prices have dropped. With stock prices lower, you basically buy new stocks, but at a much lower price.

Confused? We don’t blame you. Let’s go over the details so it makes more sense. In order to do so, we’ll use an example. Let’s say you’re convinced that the economy is going to slow down and that car sales are going to collapse. You also believe that a developing scandal at Acme Motors is going to hurt stock prices.

At the moment, Acme Motors is retailing for $50 bucks a share. You decide to short sell 2,000 shares of Acme Motors, worth a total of $100,000. Over the next several weeks your predictions prove correct, and Acme Motors shares decline rapidly. Stocks are suddenly work only $25 dollars. Now you rebuy the 2,000 shares, but you only have to pay $50,000 for them. As a result, you pocket a profit of $50,000.

Short selling is a high risk investment, however. Let’s say you’re wrong and suddenly the economy skyrockets and everyone is buying cars left and right. Meanwhile, the scandal turns out to be a non-issue. Suddenly, Acme Motor stock prices have soared to $150 dollars! Even though you only short-sold $100,000 worth of shares, you’re going to need $300,000 to repay your brokerage firm!

Short-selling is one of the few ways you can lose more than you actually put it. Even when you buy stocks, if their price drops to zero, you will only lose what you invested. With short selling your losses are not limited.

Buy low, sell high

Another thing you need to watch out for as an investor is when the bear markets end, and the bull markets return. Plummeting stock prices have to stop plummeting at some point, right? Stock markets as a whole have recovered from every single financial crisis that has beset them over the last century, and they will likely survive future crises too. Individual companies, of course, can fail.

So when markets turn bearish, you need to watch for when they bottom out. In many ways, this strategy is the crux of traditional investing. Buy low, sell high. If you bought Apple shares back when they bottomed out around a dollar, you could have potentially generated nearly unimaginable returns!

If you can predict when markets have bottomed out, which basically means when the bear market has ended, and bulls have returned, you can produce a substantial profit. Not only can you make money, but this investment strategy will generally be safer than short selling. Watching for bear markets to bottom out is a great way to profit off of bearish sentiments so make sure you keep your eye out for opportunities!