You’ve doubtlessly already heard about the terms ‘bull market’ and ‘bear market’. What do these really mean? A bear market is simply when you have a drop in a large number of share prices over a relatively long period of time. Traders normally talk about a bear market when prices have dropped at least 20% over a period of no less than two months. As more and more people sell their stocks, market prices are pushed down even further.
A bull market is just the opposite: A prolonged, widespread rise in the price of a large number of stocks. While the pessimism behind a market with declining prices drives it even further down, the optimism underlying a bull market drives the prices to even higher levels.
You shouldn’t get confuse a declining stock trading market and a normal market correction. A market correction happens after a sudden increase in the price level when people sell their stocks to take profit. It normally doesn’t last more than a few days.
It’s not difficult to understand how people make money in a bull market – it’s in fact difficult not to make money when prices go up all the time! How do traders make money while prices are dropping though?
One such way is if you could accurately predict the end of the falling market and then buy a selection of top quality stocks. Although you can use a variety of fundamental and technical indicators to help you with predicting the turning point, it remains very difficult. Even the best of traders often fail to correctly predict the turning point of a slumping market.
A further option you have is to sell stocks short. What happens in effect is that you borrow stocks from your brokerage and then sell them to another trader at the current (high) price. Once the negative market has taken its toll and the price of the stock is much lower, you buy it again and give back what you borrowed from the brokerage. It will of course only work if the market actually goes down.
Another route open to you is to buy what is referred to as “put options” in the industry. These increase in value during a bear market when the price of the underlying share drops. Once again you have to be right about the fact that the price is going to drop, otherwise you will lose the funds you paid for the put option.