Deepening Understanding of Bear Market Cycles: An Investment Guide from Identification to Response

The Definition of a Bear Market

The core definition of a Bear Market is when the price of the underlying asset drops more than 20% from its high, and this downward trend typically lasts for several months or even years. Conversely, when an asset’s price rises more than 20% from its low, the market enters a Bull Market phase.

This definition is not limited to stocks; it also applies to bonds, real estate, precious metals, commodities, foreign exchange, and all tradable asset classes.

It is important to clarify that a bear market is different from an economic recession. When the Consumer Price Index (CPI) shows a negative year-over-year growth rate, the economy may enter a deflationary state, reflecting deeper economic issues. While they may occur simultaneously, they are not the same concept.

Another easily confused concept is Market Correction. A correction refers to a short-term fluctuation where prices fall 10%-20% from their highs, occurring more frequently and lasting for a shorter period. A bear market, on the other hand, is a systemic, long-term decline that has a more profound impact on investor psychology and asset allocation.

Mechanisms of Bear Market Formation and Identification Signals

Price decline magnitude and time characteristics

The U.S. Securities and Exchange Commission recognizes a bear market when most stock indices decline 20% or more over at least two months. According to historical data of the S&P 500 index, in 19 bear markets over the past 140 years, the average decline was 37.3%, with an average duration of 289 days.

However, the duration of bear markets varies greatly. The bear market triggered by the COVID-19 pandemic in 2020 lasted only one month, while others can last several years. The most recent five bear markets show that the market typically needs to fall about 38% to bottom out and reverse, and it usually takes several years for the index to recover to previous highs.

Characteristics of Bear Markets

Bear markets are often accompanied by macroeconomic phenomena such as recession, rising unemployment, and deflation. In such environments, central banks tend to initiate quantitative easing (QE) policies to stabilize the market. Historical experience indicates that rallies before official QE implementation are often just bear market rebounds, not true exits from the bear zone.

The degree of asset bubbles is another key indicator. Price volatility in commodities often far exceeds their intrinsic value changes. When the economy is in its early expansion phase, bear markets are rare; but if assets are in obvious bubbles and investors display irrational enthusiasm, and if central banks tighten liquidity to curb excessive inflation, the market may enter a phased bear market.

Main Factors Triggering Bear Markets

Chain reaction of confidence collapse

When market outlooks are pessimistic, consumers tend to increase savings and cut non-essential spending; companies reduce hiring and expansion plans. Capital markets then downgrade expectations for corporate profits, and buying interest sharply diminishes. When these factors resonate, stock prices often experience a sharp plunge in the short term.

Bubble bursting and stampede effect

In overheated markets, asset prices are driven up to levels with no buyers. Once prices turn downward, a stampede effect can occur, accelerating the decline. During rapid rises and falls, market confidence rapidly erodes, further worsening sentiment.

Geopolitical and financial risks

Major events such as bank failures, sovereign debt crises, and regional conflicts can trigger market panic. For example, the Russia-Ukraine conflict pushed energy prices higher and increased global economic uncertainty; U.S.-China trade frictions have impacted corporate supply chains and earnings.

Tightening monetary policy cycle

Interest rate hikes and balance sheet reductions by the Federal Reserve reduce liquidity, suppress corporate and consumer spending, and ultimately dampen stock market performance.

External shocks

Natural disasters, pandemics, energy crises, and other unexpected events can all trigger global market crashes.

Review of Six Historical U.S. Stock Market Bear Markets

2022 Bear Market: Inflation Pressure and Multiple Shocks

The bear market that began on January 4, 2022, was caused by multiple pressures. Post-pandemic global central banks’ aggressive QE led to soaring inflation, while the Russia-Ukraine war caused food and oil prices to spike, worsening inflation. To curb inflation, the Fed sharply raised interest rates and accelerated balance sheet reduction. As a result, market confidence declined, and the electronics sector, which had gained the most in the previous two years, was hit hardest. Since anti-inflation policies are still ongoing, analysts expect this bear market to last at least until 2023.

2020 Pandemic Shock: The Shortest Bear Market in History

At the end of 2019, the Wuhan pandemic outbreak spread globally in 2020, triggering market panic. This became the shortest bear market in history: the Dow Jones fell from a high of 29,568 on February 12 to 18,213 on March 23, then recovered to 22,552 by March 26, falling more than 20% from the high, thus exiting the bear market definition.

Global central banks learned lessons from the 2008 crisis and quickly launched QE to stabilize cash flow, rapidly resolving the crisis. This was followed by two consecutive years of super bull markets.

2008 Financial Crisis: Decline of Over 50%

The bear market started on October 9, 2007, with the Dow Jones dropping from 14,164.43 to 6,544.44 on March 6, 2009, a decline of 53.4%.

This crisis originated from the dot-com bubble burst in 2000 and the loss of confidence after the September 11 attacks in 2001. The Fed cut interest rates sharply to stimulate the market, and in a low-interest environment, many investors borrowed to buy homes, causing house prices to surge several times in the short term. Banks, seeking to increase mortgage interest income, issued loans to credit-impaired borrowers and packaged these into financial products for resale, hiding risks at multiple layers. When house prices rose excessively and the Fed began raising interest rates, investors exited the housing market, leading to a chain reaction and the 2008 stock market crash. Even with the government’s economic stimulus plan in 2009, the bear market did not end immediately. It was only on March 5, 2013, that the Dow Jones recovered to its 2007 high.

2000 Dot-com Bubble: End of the Longest Bull Market in U.S. Stocks

In the 1990s, the internet boom drove many high-tech companies to go public, most of which were based on “high growth expectations without actual profits.” Speculation was rampant, and company valuations were severely overextended. When capital withdrew, severe sell-offs ensued. This bear market ended the longest bull run in U.S. stock history and triggered a recession. The September 11 terrorist attacks further exacerbated the stock decline, shocking global markets.

1987 Black Monday: The First Lesson in Program Trading

October 19, 1987 (Monday), the Dow Jones Industrial Average plummeted 22.62%, becoming a dark memory on Wall Street.

Starting in 1980, the U.S. market entered several years of bull markets. By 1987, the Fed had been raising interest rates steadily, tensions in the Middle East increased, and markets entered consolidation. During this period, program trading was applied on a large scale for the first time. When stock prices fell sharply in a short period, automatic sell orders triggered even larger sell-offs, creating a vicious cycle.

Learning from the lessons of the 1929 Great Depression, the government quickly adopted stabilization measures: lowering interest rates, introducing circuit breakers, and suspending trading during extreme volatility. The market recovered within 14 months. Although this caused global panic, the recovery was much faster than the decade-long downturn after 1929, showing that markets had learned to digest bearish signals.

1973-1974 Oil Crisis: Deep Adjustment in a Stagflation Environment

After the October 1973 Yom Kippur War, OPEC imposed an oil embargo and production cuts against supporting Israel, causing oil prices to soar from $3 to $12 per barrel within six months, a 300% increase. This worsened the inflation already present in the U.S. (CPI had reached 8% in early 1973), leading to stagflation—GDP shrank by 4.7% in 1974, while inflation soared to 12.3%.

U.S. stocks declined from their January 1973 highs, mainly due to economic slowdown and rising interest rates. The oil crisis and the Watergate scandal in August further damaged confidence, with the S&P 500 falling 48% and the Dow Jones nearly 50%. This bear market lasted 21 months, making it one of the longest and deepest systemic collapses in modern U.S. history. Although the Fed attempted to raise rates to curb inflation afterward, policy effects were limited, and economic recovery was slow after the bear market ended.

Investment Strategies in a Bear Market Environment

Reduce Portfolio Risk Exposure

During a bear market, maintain sufficient cash reserves to hedge against market volatility and reduce leverage. Avoid over-allocating to “high P/E” stocks and overhyped assets, as bubbles tend to burst hardest in bear markets. The stocks that soared during bull markets often suffer the deepest declines in bear markets.

Select Defensive Assets

Besides holding cash, if continuing to invest, focus on defensive sectors less affected by economic cycles, such as healthcare, consumer staples, and essential goods. Consider quality companies with solid fundamentals that have fallen significantly but maintain a stable outlook. Use their historical P/E ranges to gradually build positions at low points.

These quality companies should have a durable competitive moat, ensuring their advantages last at least three years. Otherwise, they may lose competitiveness when the market recovers, and their stock prices may not return to previous highs. For investors with less confidence in individual stock selection, investing in broad market ETFs is a safer alternative, waiting for the next economic upturn.

Use Investment Tools Suitable for Bear Markets

Bear markets have a higher probability of declines, and short-selling can be more effective. Investors may consider using derivatives such as Contracts for Difference (CFDs) to participate in short-selling. CFDs are innovative financial products that involve settling the price difference between entry and exit points, without the need to trade physical assets.

CFDs cover a wide range of assets, including global stock indices, forex, futures, individual stocks, metals, and commodities. They are effective tools for seeking short opportunities during bear markets. Many trading platforms offer comprehensive educational resources and tools. Traders can start with demo accounts to familiarize themselves with the process and prepare for future bear market opportunities.

How to Distinguish Between a Bear Market Rally and a True Reversal

A bear market rally (also called a bear trap) is a short-term counter-movement within a downtrend, usually lasting from a few days to several weeks. An increase of more than 5% can be considered a rally. Such rallies often mislead investors into thinking the market has begun a reversal or a new bull market. In reality, unless the market rises for several consecutive days or months, or the rally exceeds 20% to officially exit the bear market, it should be regarded as a rebound.

Key Indicators to Differentiate a Rally from a Reversal

Investors can look for the following signals:

1. About 90% of stocks trading above their 10-day moving average
2. More than 50% of stocks are advancing
3. Over 55% of stocks hitting new highs within 20 days

When these indicators appear simultaneously, it suggests the market has transitioned from a bear market rebound into a genuine upward trend.

Overall Perspective and Investment Mindset

A bear market is not a disaster; the key is to identify its onset promptly and employ appropriate financial tools to respond. Investors can protect assets while seeking opportunities through short-selling and other strategies. Adjusting mindset and timing are crucial, as both bullish and bearish phases offer profit opportunities.

For conservative investors, patience is vital during a bear market. Strictly adhering to stop-loss and take-profit rules for all positions can effectively protect assets. By deeply understanding the formation mechanisms and historical patterns of bear markets, and mastering corresponding strategies, investors can navigate market volatility with greater confidence.