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Last Updated on 10 February, 2024 by Abrahamtolle
If you have been active in the stock market or listening to financial news, you must have been conversant with the phrases — bull market and bear market — which are used to describe the trend in the market. While the phrases are used to describe the ebb and flow of the market cycle, what are the key differences between a bull market and a bear market?
In the simplest terms, a bull market refers to a market that is appreciating in value, while a bear market refers to a market that is depreciating in value. The key differences can be seen in the:
- state of the economy
- market sentiment
- supply and demand for stocks
- level of trading activity
- major positions in the market
- market indicators
- dividend yield
- number of IPOs
- activities in other markets
- duration
- aftermath
At the end of the article, you will find a table where we have gathered the most important information about the differences between bull markets and bear markets. If you’re interested in digging deeper and learning more, each row is discussed under its own subheading below!
1. Meaning
A bull market is defined as a period when any of the broad market indexes, such as the S&P 500 Index (which tracks the performance of 500 well-capitalized U.S. stocks) or the Dow Jones Industrial Average (which tracks 30 of the largest U.S. stock), rises by 20% or more, from the low of the preceding bear market and lasts for at least six months.
On the other hand, a bear market is a period when any of the broad market indexes, such as the S&P 500 Index or the Dow Jones Industrial Average (DJIA), declines by at least 20%, from the high of the preceding bull market and lasts for two months or more.
It is believed that the terms ‘bull’ and ‘bear’ come from the way the animals charge at their opponents — while a bull thrust its horns upwards when attacking an opponent, a bear swipes its paws downwards during a fight. So, analysts and investors use these metaphors to represent the movement of the market.
When the market is going up, it is known as a bull market, and when the market is going down, it is known as a bear market. Though bull and bear markets can be used in other assets, such as bonds, commodities, foreign exchange, and real estate, we are focusing on the stock market here.
2. State of the Economy
The stock market is strongly linked to the economy because the businesses that constitute a great part of the economy have their stocks trading in the stock market. Thus, changes in the economy affect businesses, and the performance of those businesses determines the value of their stocks in the market.
A bull market is associated with a strong economy, which is characterized by a low unemployment rate, increasing corporate profits, increasing wages and savings, and growth in GDP. As more people get employed and earn good wages, there will be a greater number of people with more money to spend.
Increased consumer spending drives the economy and helps businesses to make huge profits, which directly improves the values of their stocks in the stock market. In addition, with more disposable income, people tend to invest their extra cash in the stock market, thereby increasing the demand for stocks, which, in turn, drives up stock prices.
A bear market, on the other hand, occurs when the economy is weak or in a recession, which is characterized by a high unemployment rate, decreasing corporate profits (some companies post losses), decreasing wages and savings, and a decline in GDP. With decreasing wages and more people unemployed, consumers have less money to spend.
Reduced consumer spending affects businesses, reducing their profitability, which, as you would expect, affects the values of stocks in the market. Furthermore, with less disposable income, fewer people invest in the stock market, thus the demand for stocks decreases, leading to a decline in stock prices.
3. Dominating Market Sentiment
Apart from the effects of the general economy on the stock market, one major factor that determines how the market is going to move is investor sentiment or psychology. The way investors feel about the market and their expectations affect the direction of the market, which, on its own, influences the sentiment in the market. In other words, investor sentiment and the performance of the market are depended on each other.
In a bull market, investors tend to have a high level of confidence both in the stock market, as an investment vehicle, and in their ability to grow wealth through the market. There tends to be a great deal of optimism, and making money appears very easy. An average man in the street is eager to invest in the stock market with the expectations of making a lot of money from the market.
On the other hand, during a bear market, investors lose confidence in the market and often act irrationally. The dominating market sentiment is pessimism — investors become afraid of losing their money, as they anticipate a prolonged decline in stock prices. So, they rush to sell their stocks to avoid losses and, in the process, create a panic. The result is an imbalance in supply and demand, which drags the price down.
4. Supply and Demand for stocks
Stock prices move only when there is an imbalance between the demand and supply of stocks. When there is a higher demand for a stock than the available supply, the price of the stock will move up because the buy orders can clear all the sell orders at the current price level and move the price to the next sell orders at a higher level.
In situations when there is a higher supply than demand, the stock price will move down because the sell orders are able to clear all the buy orders at the current price level and move the price to the next buy limit orders at a lower level.
In a bull market, there are more investors willing to buy stocks than there are those willing to sell their stocks, so there is more demand for stocks than the available supply. As a result, stock prices go up as investors are competing for the few available shares.
The opposite happens in a bear market — there are more investors looking to sell their stocks than there are investors willing to buy, so the supply outweighs the demand. As you would expect, there will be a decline in stock prices.
5. Level of Trading Activity
By trading activity, we mean the average number of trades per day and the volume of shares transacted. In other words, how much liquidity is flowing in the market.
Investors are attracted to markets with higher liquidity than those with less liquidity, and they, in turn, contribute to the trading activity in the market.
In a bull market, the liquidity flow in the market is huge, as investors pump more fund into the market, increasing the level of trading activity. Fund managers tend to stay fully invested, with a high asset to cash ratio, and a higher percentage of their assets will be in stocks. Additionally, not only are previous investors buying more stocks when the market is going up, but also new investors are attracted to the market
On the other hand, in a bear market, due to the fact that stock prices are continuously falling, investors pull out of the market and move their funds to some other assets or keep a great percentage of their portfolio in cash. The effects on the level of trading activity occur in two stages:
- At first, there will be an increased trading volume as people are massively selling their stocks.
- Later on, when most investors have pulled out of the market, liquidity dries up and trading activity reduces. Moreover, new investors are not attracted to a sinking market.
6. How Investors Play the Market
There are different ways investors play the stock market. An investor may choose to directly buy or sell a stock, while another may decide to make use of equity index or single stock options contracts.
An option contract gives the buyer the right to buy or sell a stock when the price has crossed the strike price, on or before expiration. There are two basic types of options: call options and put options.
In a bull market, investors are optimistic about the market going up, so they try to use every means to maximize potential profits from the anticipated rise in stock prices. Most investors will accumulate long positions in the stock market, but some others may use the options market to bet on the expected rise in stock prices, by going long on call options.
On the other hand, in a bear market, the market sentiment is very pessimistic, and investors are pulling out of the market. As stock prices continue to decline, many investors will sell off their stocks to avoid heavy losses. Some investors, who operate margins account, may take short positions in the market in anticipation of further decline in stock prices.
The sophisticated market players may approach the options market to hedge their stock positions by buying put options — protective put. Furthermore, options speculators go long on put options during this period.
7. Market Indicators
Market indicators are mathematical formulas that analysts use to indirectly measure the attitude of investors and their expectations of future price movements.
There are several of these indicators which traders use in technical and sentimental analysis. Many of the indicators measure broad market activities, and they include the VIX, advance/decline ratio, and high/low ratio.
- The VIX is a volatility index that gauges the level of fear in the market by measuring the expected volatility in the S&P 500 Index.
- The advance/decline ratio compares the number of advancing stocks to the number of declining stocks
- And the high/low ratio compares the number of stocks hitting 52-week highs to the number making 52-week lows.
In a bull market, the number of stocks that are advancing is more than the number of declining ones, and more stocks are making new 52-week highs than the ones making 52-week lows. So, these market breadth indicators are strongly positive. Also, the VIX is low because there is less fear, as the investors are more confident.
On the other hand, a bear market is characterized by negative values in the market breadth indicators — more stocks are declining than advancing, and there are more stocks making 52-week lows than the ones making 52-week highs. Because of the rising pessimism and fear, the VIX spikes up during a bear market.
8. Dividend Yield
The dividend yield is a parameter used to estimate the dividend return of a stock investment, and it makes it easy to compare the dividend payment of various stocks. The dividend yield is a company’s annual dividend payment to its shareholders expressed as a percentage of its current price per share.
Dividend Yield = (Annual Dividend / Stock Price) x 100
Where:
Annual Dividend = sum of all the dividend a company pays in 1 year
One important thing to note here is that dividend yield can change with market conditions. From the formula, you can see that if the dividend payment remains constant, the dividend yield will increase when the price of the stocks falls and will decrease when the price of the stock goes up.
In a bull market, because stock prices are going up, the dividend yields of most stocks will be decreasing — unless the companies keep increasing their annual dividend payment at the same rate as the stocks are rising.
During a bear market, stock prices are going down, so the dividend yields of most stocks will be increasing, unless there is a commiserate reduction in the annual dividend payment.
9. Initial Public Offers
An initial public offers (IPO) is the first set of shares directly issued by a company to public investors. For a company to issue its shares to the public, it has to list on a stock exchange where investors can trade the stock. Companies go public for many reasons, but the main reason is to raise fund from the public.
Not all companies that go public are in a strong financial position. In fact, many of the companies that list for IPO are not profitable at the time of listing on an exchange — the reason they need public funds to turn their business around.
During a bull market, there are more IPOs, as poorly performing companies like to use the positive sentiment in the market to mask their ugly financial status. So, not only are more companies coming public during a bull market, but also a high percentage of them are in poor financial status.
In a bear market, there is a lack of interest in the market, so few companies are coming public. However, the majority of those companies are doing very well and only need the funds from the IPOs to expand their operations and develop new products.
10. What Happens in Other Markets
Apart from the stock market, there are other markets where investors can put their money, and they include the bond, commodity, real estate, and derivative markets. In fact, most big investors have portfolios with different asset classes in varying proportions.
When the stock market is in a bull market, other asset markets are affected in different ways. As investors move their money to the stock market, bond prices tend to decline, the yields increase. In the commodity market, the prices of various commodities will fall since less money is coming to the market. In addition, there will be more bets in equity derivatives. Most of the speculators will go long on equity index and single stock call options.
On the other hand, when the stock market is in a bear market, pessimistic investors try to reduce their stock holdings and either increase their cash levels or move their funds to other assets. As a result, bond prices increase and yields decrease because more money is flowing into the bond market. Similarly, commodity prices increase, as more money goes into the commodity market from investors that are divesting from stocks.
In the options market, equity options will see a lot of trading activity — there will be more bets on the put options. While big investors will be buying protective puts to hedge their stock holdings, speculators will take long positions on put options in anticipation of further decline in stock prices.
11. Duration
Each bull or bear market varies in duration, but most of the time, a bull market tends to last longer than a bear market.
By definition, a bull market will last at least six months, but most of them last for many years. On average, the duration of a bull market is about five years and two months.
Here you can read our article on how long bull markets last.
A bear market, on the other hand, should last at least two months. All the bear markets since the Great Depression ranged between two months and a little over five years, with an average duration of about one year and nine months.
Here you can read our article on how long bear markets last.
12. The Aftermath
The bull and bear markets are phases of the market cycle. When a phase runs its course and comes to an end, another phase begins. But how does each one — bull or bear — end, and what is the aftermath?
When a bull market is coming to an end, stock prices tend to be very high, and the P/E ratios become very high too — stocks get extremely overvalued. In addition to extreme stock overvaluation, the economy is likely to be heated up. As a result, the Fed will hike the interest rate to tackle inflation. The interest rate hike will not only slow the economy (as intended) but may also help to trigger a recession, and the result may be a bear market — the other phase of the market cycle.
On the other hand, the aftermath of a bear market is that stock prices become very low, and the P/E ratio may be low as well — stocks are cheap and undervalued. Additionally, the economy may be deflated or even in a recession. The Fed will respond by cutting interest rate or initiating an economic stimulus package to tackle the situation. This, together with other factors, leads to economic expansion, and a new bull market starts — the market cycle continues.
Bull Market VS Bear Market – The Differences
Conclusion
Basically, a bull market refers to a market that is appreciating in value, while a bear market refers to a market that is depreciating in value. Whatever the situation in the market, a smart investor can make money.
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