Lesson Navigating market volatility

What is a bear market and how does it work?

Learn how investors stay smart during bear markets to safeguard your investments.

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In the investing world, one thing's for certain: investors from all walks of life will, at some point, encounter the enigmatic beast known as the bear market. Throughout history, the stock market has endured numerous bear markets. The Great Recession of 2008 is a prime example. It was a severe bear market, but the market ultimately rebounded, and those who remained invested reaped the rewards of the subsequent bull market.

What is a bear market?

A bear market cycle is usually identified by a 20% or more decline from recent highs, and it typically commences with a phase of economic uncertainty and falling stock prices, followed by a period of negative investor sentiment. It's the opposite of a bull market, where prices generally rise.

Bull vs. Bear market?

Investors use "bearish" or "bullish" to describe market sentiment regarding specific securities or financial markets.

The difference between a bull and bear market lies in the direction of market prices and investor sentiment. Rising prices and positive sentiment characterize a bull market, while a bear market features falling prices and negative sentiment often linked to unfavourable economic conditions, such as recessions and rising unemployment, or geopolitical events, such as war. A negative outlook on future economic conditions can cause investors to lose confidence, leading them to withdraw (or sell) their investments, which results in declining prices due to decreased demand and increased supply.

While there is no fixed timeline, a bear market can last from several months to a few years, depending on the underlying causes and economic conditions.

What should I do during a bear market?

When you're in bear market territory, one of the keys to success is adopting a long-term perspective.

Investors in their 30s, for example, have decades ahead of them before retirement. During a bear market, they can see it as an opportunity to buy quality assets at discounted prices and hold onto them until the market recovers. Remember why you're investing in the first place. Whether you’re saving for retirement, a home, or your children's education, your long-term goals should guide your decisions. You can assess whether your asset allocation and investment choices align with your financial goals and risk profile.

For investors that practice value investing, which involves buying undervalued assets based on fundamental analysis, a bear market can reveal stocks trading below their intrinsic value, presenting opportunities for value-oriented investors.

Bear markets can also allow income-oriented investors to purchase dividend-paying stocks at lower prices. With Questrade, you can set up a Dividend Reinvestment Plan (DRIP) for your account that will enable you to reinvest your cash dividends automatically to purchase shares or fund units of the company that paid you those dividends. These stocks can provide a steady income stream even during market downturns and can help you benefit from compounding over time.

A bear market may affect different asset classes, sectors, and industries differently, so the best way to protect your investments in any market is diversification. 

Diversification is a tried-and-true strategy for reducing risk in your investment portfolio. By spreading your investments across different asset classes, industries, and geographic regions, you can mitigate the impact of a bear market on your overall portfolio. Diversification helps balance the potential losses in some areas and potentially benefit from gains in other areas.

Is it a good time to buy or sell during a bear market?

The answer depends on individual financial goals, risk tolerance, and investment strategies. 

Bear markets can present attractive buying opportunities for investors to acquire stocks, bonds, or other assets at lower prices than during a bull market. However, it's essential to approach investing in a bear market with caution and a well-defined strategy, especially if you are new to investing. 

Experienced investors may use bear markets to engage in short selling or hedging to protect their existing investments from further declines. These strategies involve betting on or protecting against falling prices. Some investors, particularly active traders, attempt to time the market by buying when they believe it has reached a bottom or is about to rebound. However, market timing is notoriously tricky. When in doubt, consult with financial professionals who can provide guidance based on your circumstances and risk tolerance.

Is a bear market good or bad?

Bear markets can evoke fear and uncertainty, but they can also test your resilience. It's crucial to remember that market fluctuations are a natural part of the investing landscape. 

Getting to know the historical patterns of bear markets can help you put current events into perspective. Rather than panicking, you can use this time to carefully assess your risk profile and investment goals, review and rebalance your portfolio, and consider the long-term potential of your investments rather than trying to time the market's short-term movements. 

Knowing a bear market and how it works enables you to assess and manage the investment risks. By recognizing that bear markets are a regular part of the market cycle, you can make informed decisions about your investments. Understanding that market declines are possible makes you less likely to panic and make impulsive decisions that could harm your long-term financial goals. Recognizing that these downturns are temporary and that markets historically recover can help you stay committed to your investment strategy.

Always do your research and due diligence

Bear markets can be intimidating, but they can also be opportunities in disguise. By maintaining a positive outlook, embracing long-term thinking, and employing sound investment strategies, you can navigate bear markets with confidence. Remember, history has shown that markets recover, and those who stay the course can come out ahead.

As you face a bear market, consider it an opportunity to refine your investment strategy, accumulate quality assets at discounted prices, and position yourself for future growth. Stay informed, stay disciplined, and keep your long-term goals in mind.

Note: The information in this blog is for information purposes only and should not be used or construed as financial, investment, or tax advice by any individual. Information obtained from third parties is believed to be reliable, but no representations or warranty, expressed or implied is made by Questrade, Inc., its affiliates or any other person to its accuracy.

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