What is a Bear market? History, Causes & Investment

A Bear market happens when the broad market index falls by 20% or more from the high over a few months due to negative investor sentiment. 20% is considered as a minimum threshold limit.

The opposite of a bear market is a bull market.

In a bear market, we may have occasional small rallies but the general trend will be downward. Market participants keep selling investments ignoring good news and fundamentals.

Bearish views on one or two stocks due to their change in fundamentals or for any other reason does not affect the market as a whole. The broad market index must be down 20% or more from the high due to selling pressure of almost all stocks to create a bear market.

Key Points to Remember:

• A bear market happens when prices fall by at least 20%.
• This decline generally occurs over several months.
• Bear markets are less common than bull markets (when prices rise).
• Bear markets are often caused by loss of confidence in the economy, businesses, or consumers.

What is the broad market index?

Broad market index in India means the stock market index such as NIFTY 50 and SENSEX. If NIFTY 50 and SENSEX falls 20% or more, then stocks associated with it also fall.

NIFTY 50

The NIFTY 50 is a benchmark index founded in 1997 that represents 50 large cap stocks of Indian companies listed on the National Stock Exchange (NSE). National Stock Exchange (NSE) is one of the leading stock exchanges in India, based in Mumbai.

SENSEX

BSE SENSEX is a benchmark index that denotes 30 large cap stocks of indian companies listed under the BSE (formerly known as Bombay Stock Exchange). SENSEX was founded in 1986.

For the US, broad market index means stock market index such as S&P 500, DJIA, NASDAQ composite index.

S&P 500: The Standard and Poor’s 500 (S&P 500) is an index that tracks performance of 500 listed largest companies on the stock exchanges of the US.

DJIA: The Dow Jones Industrial Average (DJIA) is a very popular stock market index that tracks the performance of 30 large blue-chip companies trading on the New York Stock Exchange (NYSE) and Nasdaq.

Nasdaq Composite: The Nasdaq Composite is a stock market index that tracks the performance of 2500 stocks listed on the Nasdaq stock exchange.

Similarly, different countries have different indexes to represent their overall market. Here is a list for your reference;

• SSE Composite Index – Stock market index of all stocks that are traded at the Shanghai Stock Exchange
• Hang Seng Index – Stock-market index in Hong Kong
• Nikkei 225 – Stock market index for the Tokyo Stock Exchange
• FTSE 100 – Stock market index comprises the 100 most highly capitalized blue-chip companies listed on London Stock Exchange
• DAX Index – Deutscher Aktien Index (DAX index) is a stock index which tracks the performance of 30 selected German blue chip stocks traded on the Frankfurt Stock Exchange
• CAC 40 – Its a french stock market index.Also known as FR40 or France 40 index.
• Straits Times Index (STI) – Comprises the stocks of 30 representative companies listed on the Singapore Exchange (SGX).

Bear market vs. corrections

Most often a bear market is confused with the term correction.

Market correction is a short term trend opposite to a bullish trend. Correction to a bullish trend helps value investors to get an entry to market at a corrected price. It provides a suitable entry if you missed the original bull trend or wants to put some more money into the market.

It’s difficult to know the bottom of the bear market. This is why many investors and traders don’t get a suitable entry point in a bear market.

Bear market ends when investors find value in the market and start buying stocks attractively priced.

What causes a bear market?

There can be many factors which can create a bear market. Investors and traders carefully analyze key economic signals, central bank’s decisions and fundamentals that can impact the market fundamentals to create a bear market.

Here is a list of factors that may create a bear market;

• Negative market sentiment
• Weak or slowing or sluggish economic conditions
• Recession
• High inflation
• Bursting market bubbles
• Pandemic
• Wars
• Geopolitical crisis
• Higher interest rates
• Rising unemployment
• Decreases GDP
• Declining corporate profits

When major changes are about to take place, the market reacts quickly based on their impact.

These factors create panic and nervousness in the mindset of the investors due to which they start selling stocks for liquidity. When investors and institutional traders believe something is about to happen, they will take action by selling high priced shares to avoid losses. 

This kind of selling continues unless they find value in the market.

When a large number of selling takes place, supply in the market increases while demand to buy them does not. This type of situation continuously lowers the prices of stock creating a bear market.

Individual stocks and securities can be considered to be in a bear market if they decline 20% or more over a sustained period of time.

Bear market can continue for years. In between, we may have small rallies for a short term period but ultimately such gains will not sustain and price will revert to lower levels.

History of bear markets in India

During 1992, BSE Sensex crashed 50% in one year due to the Harshad Mehta stock market scam. Sensex declined around 2000 points to the levels of 2500. This bear market lasted for 2 years to recover.

In January 2008, Sensex crashed around 1400 points due to uncertainty in economy, business, fear of recession and market sentiment. By the end of 2008, Sensex closed around 9700 after touching a low of 7697.39, the high in January 2008 was around 21,200. The Sensex took almost 2 years to overcome this bear market.

In August 2015, Sensex fell around 1600 points due to the threat of economic slowdown. At the beginning of 2016, Sensex continued to fall due to NPA concerns of Indian Banks. Within a period of 11 months, sensex fell around 26% from the high of 30024.74. Due to this bear market, by the end of February 2016, Sensex was at a low of 22,494.

Sensex on 14th January 2020 was at a high of 42,273.87. Due to the COVID 19 pandemic, the market fell around 38% in the month January to March 2020 to reach a low of 25,638.9. This the most recent bear market in Indian history.

History of bear markets in the US

The US market is the biggest and oldest market of the world. Between 1990 and 2023, the US market had more than 30 bear markets.

Between October 2007 and March 2009, the US market saw a bear market due to the financial crisis. During this time the Dow Jones Industrial Average (DJIA) declined almost 50%. From a high of 1,565.15 on October 9, 2007, the S&P 500 had crashed to 682.55 by March 2009.

The most recent bear market in the US is 2020 due to the global COVID-19 pandemic. Dow Jones Industrial Average (DJIA) and S&P 500 entered bear market in March 2020. DJIA fell sharply from 30,000 to 19,000. S&P 500 declined almost 34%.

Techniques used by traders in a bear market

Short selling, selling calls and buying put options are some of the ways traders use to make money during a bear market.

Short selling is a technique where trades sell borrowed shares and buy them back at a lower price to profit from the difference. Short selling is a very risky trade. Professional traders execute this strategy in the bear market. If not executed properly then it can cause huge losses.

For instance, suppose Mr Kumar shorts 100 shares of XYZ limited at a price of Rs 100. The price falls to Rs 85 within a period of 7 trading days. He bought back 100 shares at a price of Rs 85 to return it back to the broker. In this way Mr Kumar pockets a profit of Rs 15 per share, which is Rs 1,500 in a bear market.

Instead of a decline in prices, if stock of XYZ limited started trading at a higher price unexpectedly, then Mr Kumar will be forced to buy back stocks at a higher price, causing heavy losses.

Many professionals opt for put option buying instead of short selling in a bear market.

Put option gives the buyer the right to sell the underlying asset at a specific price on a specific date. As a buyer you pay less as premium in comparison to the original value of the underlying asset in order to buy the right of the put option contract.

If the price of the underlying asset moves against your expectation, then your loss will be restricted up to the premium paid for the put option. Compared to short selling your losses will be less in buying put option contracts. Instead of buying put options, traders also prefer to sell call option contracts in a bear market.

Historically, the stock market has recovered from bear markets to produce positive returns to those investors who remain invested in good stocks for a long term. One of the best ways to manage risk in a portfolio is diversification. This will help to offset losses of one investment with gains from another.

How to Prepare for a Bear Market in India

Being prepared for a bear market is crucial for protecting your investments. Here are a few ways to get ready:

• Diversify Your Portfolio: Instead of relying only on stocks, diversify into other assets such as bonds, real estate, or precious metals like gold. In India, gold is often considered a safe haven during periods of market volatility.
• Reduce Exposure to Risky Assets: During a bear market, consider reducing your exposure to risky assets like growth stocks. Instead, focus on safer options like defensive stocks in sectors such as healthcare and utilities.
• Stay Calm and Patient: Remember, a bear market is usually temporary. Stay patient and stick to your long-term investment strategy. Historically, bear markets end, and the market recovers.

Conclusion

A bear market is a challenging time for investors, but understanding its causes, how it works, and how it affects the Indian economy can help you make informed decisions. By staying prepared, diversifying your portfolio, and focusing on long-term growth, you can successfully navigate through a bear market. Whether you’re investing in stocks, bonds, or gold, it’s important to stay calm, think strategically, and remember that a bear market is just a phase in the larger economic cycle.