Smart position sizing & risk management

Back to glossary
Market Structure

Bear Market

A market condition where prices are falling or expected to fall, generally defined as a 20% or greater decline from recent highs.

What is a Bear Market?

A bear market is a sustained period of declining stock prices. The standard threshold is a 20% drop from a recent high. During a bear market, fear dominates, selling pressure is heavy, and rallies tend to be short-lived and get sold into.

Characteristics

  • Falling prices: major indexes are trending lower over weeks and months
  • Economic weakness: rising unemployment, declining earnings, recession fears or an active recession
  • Rally selling: bounces are brief and get sold aggressively. "Sell the rip" replaces "buy the dip"
  • Fear and capitulation: investors panic sell, volume spikes on red days, and VIX (the fear gauge) is elevated
  • Narrow leadership: only defensive sectors (utilities, healthcare, consumer staples) hold up. Everything else drops

Trading in a bear market

  • Short bias works: shorting rallies and fading bounces tends to be profitable when the trend is down
  • Cash is a position: there is no rule that says you have to trade every day. Sitting in cash during a bear market is a valid strategy
  • Reduce size: volatility is higher in bear markets. The same dollar risk covers fewer shares, so position sizing matters even more
  • Watch for the bottom: bear markets end with capitulation (extreme selling on massive volume) followed by a reversal. The bottom is usually obvious only in hindsight
Bear markets are where fortunes are made by prepared traders and lost by unprepared ones. The 2020 COVID crash dropped the S&P 500 by 34% in 23 trading days, then recovered it all in five months.

Related Terms

Bull Market

A market condition where prices are rising or expected to rise, generally defined as a 20% or greater increase from recent lows.

S&P 500

An index of the 500 largest publicly traded US companies, weighted by market cap. The most widely used benchmark for overall US stock market performance.