How to Recognize Bear Markets When Trading?
Learn how to identify bear markets, understand their characteristics, and effectively trade in these challenging market conditions. - Market series
This is the second post in my Market series. If you hadn’t read the first, you can find it here.
The big bad bear market. The stuff on nightmares. Where dreams die. But does it have to be a scary thing?
Bear cycles and recessions are a necessary part of the whole market cycle in today’s economy. I thereby see attempts to artificially prevent them as just postponing the inevitable, only making the consequences harder for everyone in the end. The epitome of 2008-2022 era, I suppose. I would argue it has a lot to do with the unsustainability of the demand for an ever expanding economy, monetary politics and debt cycles, but I guess one could simply claim that since they keep repeating throughout history, then they must be natural and maybe even right.
“Nature loves nothing more than to change”, writes Marcus Aurelius.
We, humans, however have a bit of a problem acclimating to this simple fact and want all things to stay the same forever, thereby perceiving change to be something bad and not simply necessary or natural, as it actually is. In trading or investing in particular, most market participants only want the price to go up, never down. Coincidentally the majority only know how to make money in bull markets.
Nothing can go up forever without periods of cooling off. We have cycles and seasons in everything. Day and night, high and low tide. We’re awake and we sleep. We have seasons depending on the Earth's position in regards to the Sun. We have hot and cold and we have bright and dark. In most cases the contrasting seasons or states are just parts of the same stick, representing one extreme or the other.
But can you really make any money trading in a bear market?
Absolutely, although it is a lot harder. It actually takes some skills to make money in a bear market, as opposed to raging bull markets, where everybody is printing money.
For most casual market participants, the best course of action would be to just take a break during bear markets, focusing on life, learning and slowly accumulating for the long run. If you want to become a good trader though, you’re going to have to learn to fight in these bear infested markets.
How do we know it’s bear market?
The truth is that in the beginning phases of a newly former bear market, you simply don’t know. After years of a relentless bull, we will inevitably mistake the first leg of the bear market as “just another bull market dip” to be bought and onward to new highs we go. Consequently we will rarely have the wits to sell the first big “dead cat bounce”, because we will indeed still firmly believe we’re in a bull market. It’s just the way of things.
There is no point playing the hero and trying to predict a trend reversal. It’s best to leave the first and the last 1/8 of the trend to the glory seeking larpers on social media and try to capture the meat of the trend instead.
A big dip in a bull market and the first leg of a bear market look exactly the same. In other words, there is no simple, foolproof way of recognizing this transition from a bull to bear market, until we’re deep into it. Everything only seems obvious after the fact. Here’s a few examples of larger bear trends/markets in Bitcoin’s history.
In the previous article we looked at various ways of defining and recognizing trends. The problem is that we can rarely be truly objective when looking at the markets. It’s something of a mind's fallacy. Comming from a multiyear bull market all we’ll see are bullish buying opportunities, even when the bears will
One rule to remember is that “each moment in the market is unique and that anything can happen at any time in the markets.”
This one mentality hack will put you ahead of 90% of all other market participants by way of expecting the unexpected and always protecting yourself from the market and from yourself.
What defines a bear market?
Well in the previous article we went through a few possible systems of defining the market conditions and for bear markets, these would mean the following:
The chart has now drawn a series of lower lows and lower highs, moving the price downward. Price has therefore been trending downward.
If you draw a trendline connecting the tops and one connecting the bottoms, you will get a sort of downward facing tunnel. This is not an exact science, you’re just looking for clues and the general direction of a trend here.
The daily 50 EMA is below 200 EMA and the price is below the 50 EMA.
The down days are more frequent and stronger than up days and bear side is more heavily represented in volume. Through long bear markets volume will be significantly lower than in bull markets and liquidity will be very compromised. Especially toward the end of a bear market in the accumulation period.
Market sentiment is decisively bearish, depressed and negative.
People and traders are now arguing amongst themselves like crazy.
The projections and predictions are predominantly negative.
There are cracks showing up everywhere with projects scamming or disappearing en masse.
There are liquidity problems all over the market, resulting in large entities defaulting, going bankrupt and exchanges closing down.
The news will also usually follow suit and bring about mostly negative sentiment and news.
Market reactions to bullish news will be practically non existent (the price will hardly move, if at all) and overly triggered on bearish news.
The normies won’t show any interest about the market anymore.
Stories of monetary losses, liquidations and capitulations will be a daily occurrence.
Price action wise, any bull move will be hammered back down and every once in a while a new low will be formed, simply indicating that bears are firmly in control. Red candles (for price and volume) tend to be larger than green candles and more frequent.
But that doesn’t mean that there won’t be bullish counter trend rallies and very bullish days in between.
Always remember that the market is designed to trick you into making false moves!
So how do you trade in bear markets?
An overly simplistic answer would be, just like in bull markets, only in reverse, right? Yes and no. It is indeed a lot easier to make money on the short side in bear markets, and much wiser to just stick to only selling while you’re in a bear market. Instead of “buying the dip” like you would in a bull market, you’re “selling the rip” in a bear market. Instead of buying, you’re selling - shorting.
This unfortunately means you’ll probably have to learn to play with the big boys in the futures markets, where leverage will prey upon your soul. There are some ways of effectively shorting by buying “short coins” for instance, or by playing with options, but that is simply another instrument, another form of shorting, so everything still stands the same. If you are a full time trader and want to become consistently profitable, you will have to learn the short game and also play in bear trends.
Disregarding leverage, which adds new risk to the conversation, long trades can have a much higher profit potential than short trades in general (but not in a bear market). The first are virtually unlimited and could sometimes even earn you more than 100x your initial investments, while shorting is capped at - 100%, so -1x and in reality a bit less than that.
Just this fact alone means that focusing on trading in bull markets is probably going to be a much better use of your time, than fighting for scraps in a bear market.
Bear markets historically tend to be shorter and more infrequent. But they do come, either in a form of bear countertrends in a bull market or in a form of a full blown “people jumping out of windows” bear market.
While being a bear in a bear market is the key to winning that game, being a bear in general (a pessimist if you will) is a very bad predisposition to have in trading and in life.
Bull markets offer a lot more opportunity, they last longer, they forgive mistakes more willingly and most importantly being a bear in a raging bull market is even more asinine than being a bull in a bear market. As our currencies are purposely devalued via inflation and with an expanding population, development and technology over time, given a long enough time frame, most markets trend upward.
Want the recipe for a bear market PTSD?
go long (buy) at the end of a bull market or at the beginning of a bear market
never sell, no stops, hodler mentality
preferably you bought some obscure shitcoin that has no real value whatsoever, to make it even more stressful as it could just disappear into nothingness
stay underwater (the price is lower than your entry) for weeks, months, even years
close your eyes and prey that you’ll survive the bear market and that a mighty bull will come and save your ass someday
This is how involuntary holders (traders turned “investors”) are made. Your capital is stuck, the only way out is through the unimaginable pain of selling for a gigantic loss. You’re trapped and for all that time, you’re living through mental and emotional hell. If you only invested a small percentage of your capital, no big deal, but if you went anywhere near “all in” you’re fucked! There is a lesson in there if you can find it!
Most of us have been there at least once at the beginning of our trading career. If this keeps happening to you however, you really have to educate yourself on managing risk and learn to take a loss, when you’re wrong on a trading idea. Many a fortune has been lost this way. You can start right here, in my Risk management series.
Losing money in a bear market is sort of the norm. Losing money by being a stubborn bear in a bull market however, makes you feel 10 times as stupid! I speak from experience.
Always keep in mind that
you are in a bear trend and
the odds favor the downside.
All things being the same
any random price pattern is more likely than not to resolve itself to the downside
trades in the direction of the trend have a higher probability of success
resistance is more likely than not to hold and reverse price
support is more likely than not to be broken, sooner or later
bear trend is more likely to continue than reverse.
Probabilities, not certainties, mind you!
In bear markets you can also expect that
the price will be sold off before reaching your bullish targets or even first resistance levels and
support levels will sooner or later be breached and stops will be mercilessly hunted on the long side.
In trending markets always first and foremost assume the continuation of the trend. In ranging markets first assume that the range will hold. Forget being a bull in a bear market, unless you’re really good and specialized as a counter trend trader. Most aren’t, so be honest with yourself on this one!
Bear markets are no place for bullish players high on hopium, who don’t know how to sell. Being a bull in a bear market is simply going against the trend. You’re fighting the current and the probabilities are heavily stacked against you.
Bear markets might forgive your mistakes on the short side, when selling, but will punish your unprotected long trades like an old testament God punishing the sodomites.
If you still decide to play on the long side
expect deep breaches of support
bid lower down the price range,
always protect yourself,
sell the first bounce you get and
never hold long trades for long (don’t be gready).
In bear markets you cannot allow yourself to hope for a bullish reversal every time you get a bottom bid (buy cheap) and hold with the desire for large profits. More often than not you’ll simply be forced to give back any paper profits you might have seen. And definitely no dreaming of new all time highs in the short term! Don’t be an idiot.
Make sure you are not emotional in your trading, especially in bear markets. Trading is not a place for romantics, attachments, strong unchanging opinions, hope or any of that nonsense. I don’t care how much you believe in some company, project, instrument, currency or commodity. I don’t care and the market doesn’t care either!
If it quacks like a duck, walks like a duck and looks like a duck - it’s probably a duck or in this case a bear market.
Trade what is in front of you, not what you think should happen or wish would happen. This may sound logical and natural but I assure you it is not. We all get attached to ideas and beliefs.
Personally I am a believer in the future of Bitcoin. I am a long term bull, absolutely. I even allow for the possibility that 1 Bitcoin will one day be worth 1 million USD. How much that will buy you at that point though, I have no idea. But most importantly, I also know there is a non zero chance of this whole idea of independent world currency going up in flames for whatever reason that I can or cannot foresee. And I also understand that there is a time to hold Bitcoin and a time to either hedge or get out completely. When the charts tell me to be careful or to be short Bitcoin, I do so without a second thought. I am a trader first, a fan second.
I can always buy back, even if I miss a few % and get a little less hard money (BTC) in exchange for weak money (FIAT). But money lost by taking a big hit is simply not an option any more. Been there too many times and I have learned those lessons the hard way.
Be a bear in a bear market and a bull in a bull market.
In the next article of this series we’ll be looking at some trading strategies that can make you money in a bear market and we’ll be setting up certain rules that we need to diligently apply in order to survive any bear market in our path. See you then!
Disclaimer: nothing here is financial advice, just a fellow trader meditating on his trading journey, sharing the lessons he learned and debating some personal opinions that are only that, opinions and nothing more.
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