o3 BLOG | Investing
Bear Market Explained: Everything Investors Should Know
While the thought of a bull market might trigger seasoned investors’ instincts, the words “bear market” can strike fear into the hearts of rookie investors who associate bear markets with loss. A bear market occurs when a market experiences prolonged price declines. When prices decline by more than 20 percent, it often triggers negative investor sentiment and worsening economic prospects. Bear markets can be cyclical or longer-term, and while the former lasts for several weeks or a couple of months, the latter can last for several years or even decades.
Of course, a real-world example of this is the global pandemic — COVID-19. Fears about the spread of the virus drove global economies into a downward spiral, sending markets into bear territory in early to mid-2020. Forbes reported that the S&P 500 dropped 34 percent by March 23, 2020, to 2,237.40. This drop marked one of the worst in the index’s history. It didn’t break past the 3,000-point mark until May 27, 2020, when it reached 3,036.13 and began climbing higher.
Other examples include wars, geopolitical crises, bursting market bubbles, and drastic paradigm shifts, causing a drop in investor confidence that can signal the onset of a bear market. Fear and herd behaviour can exacerbate declines, as a rush to protect downside losses can lead to prolonged periods of depressed asset prices. As growth prospects slow down and expectations are relieved, prices of stocks can decline as a result.
Bear markets can last anywhere from several weeks upwards to years. Rallies can occur within secular bear markets — this is where stocks or indexes trend on an upward trajectory for a period. However, the markets do not sustain these gains, and prices revert to lower levels. This upward/downward market trend is known as a secular bear market. Meanwhile, one that can last anywhere from a few weeks to several months is called a cyclical bear market.
Both definitions can have different outcomes, depending on the investor. Still, it’s important to note that bear markets usually have four distinct phases and knowing how to differentiate them is critical to protecting your portfolio.
4 Phases of a Bear Market
- High prices cause investors to drop out of needs to gather their profits
- Stock prices begin to fall sharply as trading activity and corporate profits drop.
- Economic indicators fall to below average, and speculators enter the market to capitalize
- Stock prices continue to drop slowly, and good news attracts investors to invest.
How to Invest During a Bear Market
Some investors choose to make gains in a bear market by short selling. Short selling allows investors to borrow shares from a broker before the order is placed, sell them, then repurchase them at lower prices. The amount between the price purchased and sold is what investors can make back as profit. Investors can also use put options and inverse ETFs to make gains or use the following methods:
1. Diversify your holdings
A mix of different assets is the best strategy to offset losses during a bear market. Shifting profits to gold mining stocks or commodities like gold can deliver a steadier return and build a defensive system against losses in your portfolio. Gold bonds are also attractive because they often move opposite stock prices.
2. Find attractive sectors in gold
Investing in specific sectors through index funds or ETFs can give you exposure to companies and offers more diversification than investing in a single stock because each fund holds shares in many companies.
3. Dollar-cost averaging
Dollar-cost averaging is when you continually invest money over time and in roughly equal amounts. Not only does this help you smooth out your purchase price over time, but it also ensures that you don’t pour all your money into the stock at its high.
Why It’s Good to Invest in Gold in a Bearish Market
The general rule of thumb is always to include 5-10% of gold and gold investment in your portfolio. It acts as a third asset class and adds diversification to your portfolio, making it a hedge.
Concerns about rising debt levels and inflation have boosted gold as investors see its role as a long-term store of value. Additionally, a low supply of gold, or scarcity, means that the price will always outpace currency produced at low-interest rates. When businesses weaken during a financial crisis and bankruptcies pile up in a recession, investors who own gold can be sheltered from risk. What’s more, it holds better value in times of uncertainty, so investors can quickly liquidate it to raise cash.
While there are many upsides, there is a risk, like with everything. Gold is not immune to sell-offs, although it’s unlikely. Traditional assets like gold become desirable in a bear market, and that’s when it gets expensive to acquire. Further, scarcity can make it difficult to purchase in large amounts. Gold dealers might have difficulty sourcing physical coins and bars, thus charging higher premiums than usual. Although gold prices over the long term are steady, they can swing because of the surrounding turmoil quickly. However, diversifying your portfolio in gold stocks, ETFs, and other futures options could help you avoid unnecessary losses.
The Bottom Line
Signs of a bear market could come one day, but that shouldn’t lead to a sudden investment strategy change. Long-term investors should consult historical data but not rely too heavily on it to predict the market. Instead, ensure that your portfolio is well-funded with a foundation of money that you won’t need for the next five years and ensure that it is both well-diversified and aligned with your risk tolerance. Doing so means you’ll likely ride out the highs and lows of the market better than someone trying to time it.
To learn how O3 Mining can add long-term value to your portfolio, contact us today.
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