Bear markets have a nasty habit of showing up every four years or so.
Like unwanted relatives, they show up whether we want them to or not.
They also have the nasty habit of taking away the punch bowl. And just when everybody is ready for a nice sip of that wonderful nectar. It doesn't seem fair and many folks wonder why.
But listen up...fairness has nothing to do with the market.
Bear markets have a very definite purpose. They clear up the excesses that have developed since the last bear market. It's kind of like when we indulge ourselves over a period of months and, lo and behold, we wake up one morning 20 pounds overweight.
We have to go on a diet or buy a bunch of new clothes. Bear markets are the market's way of putting us on a diet.
Most folks don't like them but they are a fact of life.
So where do we stand now?
The market has been a little wobbly recently and you hear some people starting to use the b word...as in bear. It makes you wonder what the market is telling us. Is the current weakness a normal correction or is the market telling us something else?
Let's look at the evidence and see what we can make of it.
Bear markets are definitely an ongoing reality and occur with some regularity. In fact, during the last 100 years there have been 19 bear markets. And, for our purposes, I am defining a bear market as a decline of 20% or more in the Dow Jones Industrials.
Reviewing these 19 bear markets reveals some interesting facts...
The average time from the end of one bear market to the beginning of the next is 45.3 months.
The average length of a bear market is 18.5 months.
The average bear market results in a decline of 36%.
While this is valuable information, keep in mind that these are only averages. The individual bear markets varied widely in length of time and severity of decline.
For instance, the longest bear markets lasted about three years. Specifically, they lasted 31, 34, and 37 months for the bear markets ending in 1942, 1932, and 1949 respectively.
The shortest bear market lasted two months. This was the crash in 1987 when the Dow Jones Industrials plunged 36%.
If you're wondering about the most severe bear market, you probably know the answer. Yep...it's the one associated with the start of the great depression...it ended in 1932. But this was only after it had sheared 89% off the value of the Dow.
And the mildest bear market? The 3 month affair that ended in October, 1990 which took 21% off the Dow.
Now...these are all interesting facts...but the question is...are they useful in analyzing the current market?
And the answer is yes. But they are only part of the process.
They're useful in that they gives us some parameters to consider. But they're only that...parameters. An actual determination of a bear market may take several months.
However, with that in mind, here's what the averages tell us...
45 months from the end of the last bear market in October, 2002 is July, 2006.
If the market high of 11,670 on May 10 was a market high, an average decline of 36% will take the market down to around 7,470.
If the market high was May, 2006, the average bear market length of 18 months will end in November, 2007.
Am I saying a bear market is here and ready to unfold according to these averages? Of course not. I'm not even saying the market top is in.
This is only to point out certain facts related to bear markets in what seems to be turbulent economic times. That, plus the fact, that, historically speaking, this current bull market may be getting long in the tooth.
However, one fact is perfectly clear. History tells us that a bear market will occur again.
And, unfortunately, when they do occur, they strike fear into the hearts of investors. People who buy and hold are never ready for bear markets. Because of their buy and hold mentality, many investors try to ride them out.
It's often not a pretty picture to sustain losses of 20%, 30%, or more in one's portfolio.
Traders, however, are different. They don't fear bear markets. They view them as another opportunity to make money.
In fact, money is often made quicker in bear markets. Markets generally go down faster than they go up. Yeah...traders don't fear bear markets...they enjoy making money faster. And they trade them like any market...with their trading system and money/risk management.
So, is a bear market at hand? Nobody knows.
However, there are signs to look for...
The market declines below its 200 day moving average.
If it's not a steep decline initially, the market may trade around the 200 day moving average for a while.
Declines are larger and last longer than previous corrections.
Sharp rallies occur but they fail to make new highs.
Look for a long term Elliott Wave count...5 waves up to the recent high.
The market starts making new lows.
These are some of the things you will likely see once the market tops out and begins rolling over into a bear market.
However, it may take a while before you know for sure. It's like everything else associated with the market. There are no certainties...only probabilities.
But we know one thing is a near certainty. There will be another bear market. We just don't know when.
However, it never hurts to look ahead. When a bear market starts, a lot of quick profits will be there for the taking.
Thomas McNatt trades full time. His website, http://www.trading-stocks-profits.com is a valuable source of information and resources for traders.
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