The stages of a bear market and what they tell investors

Key Points

• A bear market is a sustained downward market trend characterized by fear and panic selling. 
• By anticipating the four major stages of a bear market cycle, traders and investors can hedge against losses and prepare for the bull's return. 
• Learn more about the multiple stages of a bear market.

When the economy is in a bear market, it can feel like losses are never-ending. 

Understanding a bear market's stages can provide a new perspective and help you stick to your long-term trading plan. 

Read on to learn more about the four major stages of a bear market, what they mean and how to recognize them. 

What are the stages of a bear market?

The bear market is a complex financial phenomenon involving an overall downward market trend sustained over a long period. Most bear markets comprise the following four distinct stages. 

Initiation

The first step of a bear market is the initiation stage, differentiating it from any other market slowdown. It's never a good idea to assume that every negative market movement represents the beginning of a bear market cycle, as this can turn temporary losses into permanent ones. Assuming that a 5% weekly loss will eventually turn into a 20% or more loss, you may feel pressure to liquidate your assets when the prices are more likely to correct unless you reach the initiation phase. 

The initiation phase of a bear market is one of the first stock market stages to indicate that an economic downturn may signal the beginning of a larger negative trend. The anatomy of the bear market states that, as a general rule, you can consider a downturn of 20% or more to indicate an official bear market. In the initiation stage, investors notice that downtrends might be here to stay, resulting in increased pressure to sell. 

Acceleration

During the acceleration stage of a bear market, investors panic when they see the market decreasing significantly in value overall, leading to individual losses equal to each position. This is one of the most volatile stages of bear market conditions, making it difficult to predict when the stage ends. 

As market conditions worsen, fear and pessimism intensify among investors. A rapid and sharp price decline marks this stage as panic selling ensues. Investors in denial during the initiation stage may now realize the severity of the situation and rush to sell their holdings, further driving prices down. The specific percentage the market decreases will vary depending on the bear market trigger but usually ranges between 30% and 35%. 

Despair and capitulation

After the panic selling subsides and people get accustomed to the "new normal," the market enters a stabilization phase. Prices may continue to fluctuate, but the pace of decline slows down. During this stage, some investors with a longer-term perspective may see value in the lower prices and cautiously re-enter the market.

Predicting when the market is entering a stabilization period can be difficult, as most bear markets have temporary periods of increased price movement. For example, a common occurrence during this stage is the dead cat bounce, a sharp, upward but temporary period of positive movement. A dead cat bounce may "trick" investors into believing the stabilization phase has arrived, leading to more drastic losses compounded when the bounce ends. 

Early warning signals

Seasoned investors know that identifying the early warning signals can help navigate a bear market. These, if heeded, can potentially save your portfolio from big losses. So, let's take a look.

One of your primary sources of information comes from economic data points. Carefully analyzing key economic indicators such as GDP growth, employment rates, inflation levels and consumer sentiment can provide keen insights into the economy's health.

Watch the performance of specific sectors or industries. A slowdown or decline in traditionally considered defensive sectors, such as healthcare or consumer staples, may mean an impending bear market. Monitoring the performance of cyclical sectors like technology, financials, and industrials can give clues about the market's overall strength.

Increased market volatility, as measured by indicators like the VIX (CBOE Volatility Index), can signal uncertainty and potential market downturns. A sharp uptick in the VIX or sustained high levels of volatility may indicate that investors are becoming more cautious.

Pay attention to market breadth, which measures the number of stocks participating in an upward or downward movement. If a bear market is coming, you may see a decline in market breadth, with fewer stocks showing positive momentum and more stocks in negative territory.

Another signal to watch for is a divergence between the performance of major indices and individual stocks. If the broader market indices are reaching new highs while a large number of individual stocks are underperforming or showing signs of weakness, it could be a sign that a bear market is on the horizon.

What bear market stages tell investors

The 3 stages of bear market conditions can provide valuable insights and signals to investors, helping you understand the current market environment and make informed decisions. Here's what each stage of the market can tell you. 

• Initiation: This stage is the early phase of a bear market when some economic indicators and market data show signs of a slowdown or deterioration. During this stage, investors should become more cautious and pay closer attention to their investments. It's a time to review the fundamentals of your companies or assets and reassess your unique risk tolerance if the market continues on a downtrend.
• Acceleration: As the bear market progresses, fear and pessimism intensify among investors, leading to panic selling and significant declines in asset prices. This stage serves as a warning sign to investors to avoid making hasty decisions driven by emotions. Panic selling can lock in your losses and may not be conducive to long-term investment success. Remain calm, review your investment objectives and keep your long-term goals in mind when deciding how to move through the bear market phases.
• Despair and capitulation: During this stage, the sharp declines start to slow down, and market volatility may decrease. This stage can provide a ray of hope for investors, indicating that the worst may be over. It may be an opportune time to look for potential buying opportunities if assets are undervalued and align with your investment goals.

Historically, the average bear market drawdown lasted between 196 days to one year. While the midst of a bear market can seem hopeless, the most important thing to remember is that market movements naturally fluctuate. Stick to your trading strategy, and avoid attempting to time the market with significant investment funds. 

Historical bear market stages

The stages of a bear market can feel never-ending when you're in the middle of them. Keeping historical bear markets in mind can provide some perspective to help you stick to your trading strategy and avoid prematurely selling your assets. The following are four famous historic bear financial markets and how they played out.

Great Depression

The Great Depression was a severe and prolonged economic crisis throughout the 1930s. It began with a major stock market crash on October 29, 1929, often called "Black Tuesday" because it triggered the subsequent recession.

In the recognition phase, the severity of the stock market crash became evident. When stock prices plummeted, it signaled the end of the Roaring Twenties' economic boom, which threw investors into panic. The recognition phase of the Great Depression lasted until the early 1930s, when investors could no longer deny that a bear market was in effect. 

The panic phase saw a severe contraction in economic activity from 1930 through 1933. Widespread fear and uncertainty led to a massive wave of bank runs, where people rushed to withdraw their money from banks, leading to numerous bank failures. As unemployment rose dramatically, consumer spending decreased, leading to further economic decline.

The stabilization phase began in 1933 when Franklin D. Roosevelt assumed the presidency. He implemented economic reforms known as the "New Deal" to combat the Depression, including the Works Progress Administration (WPA) and Social Security. While it took years to stabilize the economy, the actualization period began in the late 1930s, near the beginning of World War II. 

2007 Financial Crisis

The recognition phase of the crisis began around 2007 when the United States experienced a housing market downturn. Many subprime mortgages (high-risk loans to borrowers with weak credit) started defaulting, leading to a significant increase in foreclosures. As these mortgage-related losses piled up, financial institutions that held mortgage-backed securities and complex derivatives tied to these assets started facing severe losses and liquidity problems.

The panic phase unfolded in late 2008 as the crisis intensified and the domino effect of financial contagion became evident. Major financial institutions faced severe difficulties, leading to a loss of confidence in the banking sector. Investors worldwide faced significant losses as stock markets plunged, credit markets froze, and access to capital became extremely difficult.

The stabilization phase started in late 2008 and continued into 2009, as governments and central banks implemented unprecedented measures to stabilize the financial system and support economic recovery. For example, the Federal Reserve lowered interest rates to near zero to inject liquidity into the markets. 

The Dot-Com Bubble

The Dot-Com Bubble was a speculative frenzy in the late 1990s and early 2000s, in which investors rapidly bought and sold internet companies' stocks, causing a crash. The recognition phase of the Dot-Com Bubble occurred in the mid-to late-1990s, when the internet and technology sectors experienced exponential growth and investor enthusiasm. The newly introduced World Wide Web prompted investors and venture capitalists to pour millions into sometimes dubious internet ventures.

The panic phase began around early 2000 when the euphoria surrounding dot-com stocks peaked and faltered. Despite having little or no revenue, many internet companies were valued at exorbitant levels based on speculative expectations of future growth. 

As some high-profile dot-com companies failed to meet investors' lofty expectations and started reporting losses, investor sentiment shifted rapidly, causing a massive selloff that plunged prices. The stabilization phase occurred from 2002 onwards as the dot-com bubble had largely deflated, leading to sharp declines in many internet-related stocks.

Black Monday (1987)

While not as well-known as the Great Depression, Black Monday was another significant stock market crash that altered U.S. history. The recognition phase of Black Monday began in the weeks and months leading up to October 19, 1987, when global stock markets experienced a notable uptrend in prices. Various factors fueled the rally, including the growing popularity of computerized trading systems, facilitating rapid and large-scale transactions.

Panic set in on Black Monday, October 19, 1987. The Dow Jones Industrial Average plummeted by 22.6%, one of the largest single-day percentage losses in the index's history. After swift liquidity injections, the stabilization period began in the weeks following the crash. 

How to invest during various bear market stages

Each of the bear market stages presents unique opportunities for investors. Here's what to consider when buying stocks, ETFs or other assets during each stage. 

• Recognition: The recognition phase is about staying on top of changing market news. Maintain a well-diversified portfolio to spread risk across various assets and sectors, and consider adding hedge assets to minimize loss in the coming downward period. 
• Panic: Panic can drive extreme market volatility, leading to irrational decisions. Smart investors resist the urge to panic sell during sharp market declines. Recognize that market downturns are often temporary, and knee-jerk reactions can lock in losses you may not have otherwise realized. 
• Stabilization: As the market stabilizes, consider rebalancing your portfolio. Rebalancing involves adjusting the portfolio's asset allocation back to its original targets, which helps you capitalize on potential gains in assets that have appreciated. It also allows you to take advantage of better entry points for assets you've considered adding to your portfolio. 
• Anticipation: As you get good news and the market recovers, plan your investment returns. Choose an exit point if you're a short-term investor or divide dividends if you plan to hold the assets longer. 

Recovery strategies

It's inevitable. Eventually, you'll find yourself in the middle of a bear market. That's when it's time to employ strategies that can help you weather the storm. Let's explore a few.

• Portfolio diversification: Diversifying your portfolio across different asset classes and investments is a tried-and-true strategy. By spreading your investments across stocks, bonds, real estate and alternative assets like commodities or precious metals, you can offset losses in one area with gains in another.
• Alternative investment strategies: Consider exploring alternative investment strategies that seek to generate positive returns even in a bear market. These strategies, such as long-short equity, market-neutral or managed futures, aim to capitalize on market inefficiencies or take advantage of trends. They let you potentially generate positive returns when traditional investments are struggling.
• Active risk management: Consider implementing stop-loss orders or trailing stops to protect your downside and limit potential losses. Regularly review your portfolio and rebalance to maintain your desired asset allocation and risk tolerance.
• Seek opportunities: Look for undervalued stocks or assets that may have been overlooked or oversold during the market downturn. Look for investments that have strong fundamentals and long-term growth prospects. Remember, in times of despair, you'll find hidden gems.
• Dollar-cost averaging: Use a dollar-cost averaging strategy to mitigate the impact. Investing a fixed amount at regular intervals, such as monthly or quarterly, allows you to take advantage of market fluctuations and potentially buy more shares when prices are low.
• Stay informed: Keep a close eye on market news, economic indicators, and company earnings reports to stay informed about any developments that may impact the market. This knowledge will help you make informed decisions and adjust your strategies.

Remember that bear markets are a normal part of the market cycle. While they can be painful, take the long view and not make impulsive decisions based on short-term market movements. Stick to your investment plan, stay disciplined and have confidence in the fundamental strength of your portfolio.

Learning from history

They say history doesn't repeat, but it rhymes. Through the years, there have been bear markets that have left investors feeling uncertain and anxious. However, they also provided valuable lessons we can learn from going forward.

The stock market crash triggered the Great Depression of the 1930s, resulting in unemployment, bank failures and a major decline in economic activity. The aftermath of the Great Depression taught us the importance of diversification and risk management.

Investors who had diversified their portfolios across various asset classes better withstood the severe losses. They had allocated their investments in stocks and bonds, real estate and other alternative assets. This diversification helped to mitigate the impact of the stock market crash and provided some stability during the economic downturn.

Another bear market that taught us valuable lessons was the 2008 financial crisis. The housing bubble fueled the crisis and the collapse of major financial institutions. The United States entered a recession, and investors suffered significant losses as stock prices plummeted and retirement accounts dwindled.

The crisis highlighted the importance of active risk management. Investors who had implemented stop-loss orders or other risk management strategies were better able to limit their losses and protect their portfolios to some extent. The subprime mortgage crisis, which caused large numbers of homeowners to default on their mortgages, also emphasized due diligence and understanding of underlying assets before making any decisions.

The 2008 financial crisis also underscored the importance of staying informed and aware of market conditions. Investors who closely followed economic indicators and company earnings reports were better prepared for the impending crisis and were able to make more informed decisions.

Despite the hardships, these bear markets also presented unique opportunities. Investors who had the foresight to identify undervalued stocks or assets were able to capitalize on their potential long-term growth. Taking a contrarian approach positioned them for significant gains when the market recovered.

Investor psychology in bear markets

The fear and uncertainty in a bear market can lead to irrational behavior and poor decision-making. Don't fall into any of these traps.

One common psychological pitfall is the herd mentality. When investors see others panicking and selling off their investments, they often feel compelled to do the same, fearing they'll miss out on any gains or exacerbate their losses. Fear and uncertainty can create a self-fulfilling prophecy, driving prices down and causing more panic in the market.

Another cognitive bias in bear markets is loss aversion. Research shows that people tend to feel the pain of losses more intensely than the pleasure of gain, leading them to make impulsive decisions based on fear rather than rational analysis. They may sell off their investments at the first sign of trouble, locking in their losses and missing out on potential gains when the market eventually recovers.

Confirmation bias is another psychological trap. This bias causes us to seek information confirming our preexisting beliefs and ignore or dismiss any evidence to the contrary. In bear markets, investors may only pay attention to negative news or opinions that support their pessimistic outlook, further reinforcing their fears and preventing them from seeing the potential opportunities.

Investing in a bear market

Timing the stock market is difficult even for experienced investors. While it can be tempting to get caught up in the fear and panic of a market selloff, the best course of action for long-term investors is to stick to their defined trading strategy. Markets rise and fall over time, but it's important to remember that you don't lock in a gain or a loss until you sell the assets you own. 

FAQs

The following are some last-minute answers to your questions about bear market stages. 

When do you know a bear market is over?

Determining when a bear market is over is challenging and often requires the benefit of hindsight. Typically, a bear market is over when there is a sustained upward trend in asset prices, signaling a significant recovery from the previous decline. However, it's common to confuse bounces and rallies with the end of a bear market. 

How long should a bear market last?

Historically, bear markets in the U.S. have varied widely in duration. On average, bear markets have lasted around one year. Numerous factors, including the economic downturn's severity and policymakers' actions, can influence its duration. Some bear markets have been shorter, lasting several months. In contrast, others have extended for more than two years.

What are the stages of the bull and bear market?

The stages of a bear market usually include recognition, panic, stabilization and anticipation. The stages of a bull market may consist of accumulation, public participation, optimism and distribution.