In the financial market, a market trend is described as the market’s proclivity to move in one way for an extended period of time. This means that, depending on the market trend, security prices will either climb or fall. This financial market tendency is divided into two types: bull markets and bear markets, which are diametrically opposed. Because market trends have a direct impact on an investor’s portfolio, they are said to affect an investor’s decisions.
Bull Market vs Bear Market
A bull market is a market environment in which stock prices are rising and are expected to rise for an extended length of time. There is broad confidence about the stock market’s performance in general, which has led to an increase in demand. A bull market frequently denotes long-term favorable returns.
A bear market, on the other hand, is a market trend in which a company’s share prices are decreasing and investors are gloomy because they are losing the value of the shares they own/hold. Stock prices are volatile, and investors tend to withdraw from the stock market and hold cash in order to preserve the value of their initial investment.
The characteristics of bull and bear markets have been described under the following headings.
1. Market Forces; Demand and Supply
A bull market is distinguished by high demand for securities. During bull markets, stock prices rise all the time. Higher returns on securities motivate traders and investors to purchase stocks, allowing them to book profits. There are more buyers in the market, but investors who hold positions in the relevant equities will not sell them. This means that during a bull market, there is a high demand for securities, which drives up prices due to a lack of supply in the market.
A bear market, on the other hand, is distinguished by a large supply of securities. The prices of assets are falling, causing fear among investors, who begin dumping their holdings. They tend to lose a large amount of their investment as a result of panic selling, which could have yielded good returns had they waited for the market to recover. Because investors risk losing money if the value of their stocks falls further, they often prefer not to invest, resulting in limited demand. However, supply is increasing because consumers believe selling is the best option, causing equities to lose value.
2. Investor’s Confidence
The psychology of an investor is directly related to stock market performance. A bull market signifies an efficient stock market performance with rising stock prices, which increases investor confidence and, as a result, investment. During a bear market, investor confidence plummets to new lows. Investors do not expect much from the stock market other than a loss on their investment, which leads in a fast withdrawal.
3. Impact on the Economy
A strong economy is the result of a bull market. People feel that their investment is currently yielding positive returns or has the potential to do so in the future. As a result, consumer spending is high at this time. To meet the increased demand, the country’s employment rate rises, indicating a thriving economy. During a bear market, the exact opposite would occur. During this time, the economy suffers as investors lose faith in the stock market. As investors withdraw their investments, the flow of money to the productive sectors decreases, forcing enterprises to lay off workers.
The “Buy and Hold” strategy is founded on the Effective Market Hypothesis (EMH), which claims that stock prices reflect all available information and are fairly priced, eliminating the need for trading. The market, however, is not always efficient. The 2008 global financial crisis is a prime example. According to market strategist Jeremy Grantham, financial leaders’ conviction in EMH has resulted in a chronic underestimate of the consequences when asset bubbles burst. As a result, in order to preserve our investment during poor market situations, we must employ a variety of tactics.
Bull Market Strategies:
1. Prioritize Quality
During the early stages of a bull market, stock prices of both good and bad companies grow in value. Waiting a time before investing is a wise decision. A bull market rewards select corporations with increased valuations over time. Moving towards quality is one of the fundamental characteristics of a bull market. As a result, if you are new to investing, this allows you to invest in a good firm rather than losing money on companies with inorganic growth.
2. Have a Financial Plan
A financial plan can help you invest your money in the highest risk-adjusted returns. Determine how much you want to invest in stocks, bonds, gold, and other liquid assets. When this allocation becomes distorted, ensure that it returns to the original plan. Money is spread around, ensuring you automatically booked profits at greater valuations and liquidity when cheaper options are available.
3. Growth Investing
This approach seeks equities of relatively new companies that are anticipated to move in a good manner due to strong fundamentals. Investors can buy stocks after conducting a thorough fundamental research of the companies. A bull market allows a good company to flourish and allows investors to grow alongside it.
4. Value Investing
The idea behind value investing is to buy undervalued equities that are on sale at a lower price. This method works well in the early to mid-stages of a bull market. This is because companies with high inherent worth may not have enough demand while the market is recovering, allowing you to buy them at a bargain and benefit from them. Investors must base their buy decisions on the company’s ‘price to earnings ratio,’ ‘price to book value ratio,’ and ‘price to sales ratio,’ which represent the value investment’s strength and weakness.
5. Determine an Exit Point
This is true for both earnings and losses. One thing we must keep in mind is that the bull market trend will not persist forever. This tendency will endure for a specific amount of time. Financial market fluctuations are common. If you bought stock during the bull market, you can’t expect it to keep climbing indefinitely. The risk of loss exists since you never know when the market may enter a bearish trend. As a result, you must always have an exit point in mind. At this time, the investor will have realized a profit on his or her investment and will sell the shares in order to prevent becoming greedy and expecting more profits from the investment.
Similarly, losses should not be held for an extended period of time. During bull markets, investors are terrified by rising stock prices, leading them to buy stocks after they have hit their top. The investor suffers a loss after this point, but may continue to hold it in the hope of a price increase. Setting an exit point for losses is a good way to ensure that you minimise the chance of loss in your investment.
Bear Market Strategies:
1. Do Not Panic Sell
During a bearish cycle, stock prices fall, which has a huge influence on an investor’s portfolio. One common error that investors make is to begin panic selling. We may believe that it is the best method to protect oneself from potential losses from an economic crisis; yet, we do not take into account the possibility of a market comeback. Stocks of excellent firms whose prices have fallen due to the changing market trend may be lost as a result of panic selling.
2. Invest in Money Market Securities
During a bear market, the stock market is turbulent; consequently, an investor should invest in highly liquid money market instruments. Certificates of deposit (CDs), treasury bills, and other money market instruments are examples of such securities. They have a shorter maturity period and are seen as risk-free investments during times of uncertainty.
3. Buy Good Stocks That Are Underpriced
One advantage of the bear market is that even the stocks of well-performing companies are undervalued, providing an excellent opportunity for investors to acquire these stocks at a lower price. Prices must fall by at least 20% in order for a bear market to develop. The stock values of both strong and weak companies fall, which is very appealing to investors. Because good companies suffer as a result of a bearish trend, investors should invest in them to make good returns when the market rebounds.
4. Invest in Defensive Stocks
The changing market patterns have little impact on defensive stocks. It refers to stocks of companies that manufacture necessities such as shampoo, toothpaste, and so on. As a result, demand for such commodities remains consistent during both economic booms and busts. Even during a bear market, the stock values of such industries do not fall due to the constancy of demand. As a result, it is prudent to invest in defensive stocks to protect against losses that may arise as a result of investing in volatile equities.
Make sure your portfolio is well-diversified by investing in stocks, bonds, cash, real estate, and other assets. This distributes your risk and gives you flexibility during a downturn. It protects you from harm by preventing you from putting all of your eggs in one basket. A solid asset allocation strategy can be developed based on an individual’s risk tolerance, investment objectives, investment horizon, and so on. It ensures that your assets are performing well even when the market is declining. An increase in the value of some of your investments will compensate for any losses and provide a higher overall return for your portfolio than the market. Perhaps nothing is more important than diversity to help you withstand a tough market.