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Bull And Bear Markets Require Different Approaches

Any one who has invested their money in the stock market for appreciable lengths of time, several years or more, respects the fact that their investments will go up and down in price, and there are no guarantees, one way or another.

These cyclical swings in value often happen whether the investment is fundamentally sound or not. The share prices of the biggest, most quality blue chip companies in the world can go down “in sympathy” with everything else, and stay there, should the news of the period be negative enough.

When this turn of events occurs in the stock market, it’s commonly referred to as a bull or bear market. In “bull markets” overall prices go up, and in “bear markets” prices go down. External, and completely unrelated events can have a profound impact on the direction of stock prices. Economic reports, Federal Reserve meetings, company earnings announcements, news events, these all impact stock markets as a whole.

The price of the overall stock market is often measured by their “indexes”. These are a representative basket of company stocks, such as the Dow Jones Industrial Average, composed of 30 large companies, or the S/P 500 which is the top 500 largest actively traded companies in the U.S.

Often to their detriment, investors easily get caught up in the excitement and frenzy of a roaring bull market. They check their stock prices every 5 minutes when positive feelings abound and everyone begins counting their “paper profits” and envisioning exotic vacations.

And more often than not, they’re hopes are dashed when a sudden negative turn of events or psychology swings prices in the other direction, into a wealth-evaporating bear market. It’s particularly telling when one looks at a historical stock price chart. It’s plain to see the pattern – stock prices usually go down much quicker than they go up.

Given that reality, its worth bearing in mind some fundamental lessons about “bear markets”. Especially when the intrepid investor finds themselves in the midst of a “bull market” that feels like it will last for quite some time. These safeguards will help to protect against disastrous losses, reduce stomach acid production, and make sleeping easier.

1. Purchase quality investments that have been thoroughly vetted by someone with the necessary expertise to do so. This is indeed rocket science. These are holdings that you should feel comfortable owning through thick and thin if need be. That is, unless some factor, specific to the company has changed mandating a decision be made.

This is solid advice because these are the companies that will regain their losses soonest after the bear market ends. They are the quality firms with strong fundamentals and operations.

2. Maintaining realistic expectations will help to keep you in line and not overly emotional. A large percentage of investors cut their teeth during the tech boom of the 1990’s. A sudden ability to buy and sell stocks on their own through Internet-based brokerages, a basic ignorance of stock investment best practices, and lots of bad or misleading advice led many neophyte investors to expect unrealistic returns “for the long run”

Even many otherwise conservative folks were under the misguided impression that 15%-20% per year gains were the new norm. That belief system quickly came to pass as investors saw huge percentages of their portfolios disappear after the crash.

The fact is that the stock market has averaged roughly 7% a year returns over the long haul. That should probably continue to hold true, more or less, over the long term. Nevertheless, year to year returns are always uncertain and unknowable.

3. Know your risk tolerance. When prices decline and you find yourself panicking or are constantly contemplating selling your holdings, then you’ve taken on too much risk.

Investors who are successful over the long term often look at “bear markets” as a period when stocks are “on sale”. They know their companies in and out thus they are comfortable confident and don’t go into panic mode. If the case merits, they buy more.

So ask yourself how much you can afford to lose and still maintain your goals. This result changes as you progress through life and as your personal circumstances and account balances change. At some point you may consider diversifying out of riskier investments such as stocks and into safer investments but with lower returns, such as bonds or certificates of deposits.

Regardless, base your investment decisions on principles and fundamentals.

Principles include risk diversification and life circumstances. These factors will indicate how you should set up your investment portfolio.

Fundamentals are items such as valuation metrics like PE ratio and dividend yields. They help to determine how “cheap” or “expensive” a stock is. Expensive stocks fall hard and fast in a bear market. A lesson learned by many after the market crash in 2000-2001.

And at all times, maintain adequate liquidity and cash cushions. Life is full of unexpected events like medical emergencies. If you sell during bear market lows because you had inadequate cash savings available, you’ll be guaranteed to be extremely dissatisfied with your investing practices. On the other hand, if you keep a certain percentage in lower return, but safer. more liquid investments, you’ll be happier when you have to write that check.

Overall, the best approach is to remain patient during bull markets and be aggressive during bear markets. Essentially the opposite of what most average investors do, but exactly what the world’s best investors do.

 

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