Modules for Beginners
Navigating Bear Markets
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Can you predict the end of a bear market?
After going through the previous chapter, you must have gotten a fair idea of how long a bear market could last. Now, in this chapter, we’re going to take a look at whether or not the end of a bear market can be predicted. And if it can, is it possible to predict the end accurately? Let’s find out.
Can you predict the end of a bear market?
Again, the answer to this question is quite simple. No one can accurately predict the end of a bear market. The reason for this is that there are simply too many variables involved. Measuring and tracking them to a high degree of accuracy is simply not possible. And in addition to that, there’s also the ‘market sentiment,’ which is something that’s constantly fluctuating.
That said, there are certain ways through which you can try to roughly estimate when the bear market is likely to bottom out and turn into a bull market. But then, here’s something that you need to know. These indicators that we’re about to look at may not work all the time. They may generate false signals from time to time, as well. Sometimes, the market might just choose to not follow through with the predicted path. With this disclaimer out of the way, let’s move on to the most exciting part of this chapter.
How to estimate the end of a bear market?
There are four primary tools or indicators that you can use to estimate the end of a bear market:
- Candlestick charts
- The volatility index VIX
- Market conditions
- Economic indicators
Let’s take up each of these, one after the other, starting with candlestick chart analysis.
1. Candlestick charts
Of these four methods, technical analysis using candlestick charts is by far the most accurate way to predict the end of a bear market, if at all. As you’ve already seen in another module of Smart Money, candlestick charts help you identify and predict market trends, including primary trends such as bear markets and bull markets.
Since we’re dealing with the estimation of the end of a bear market, which is most likely always a primary trend, analyzing single candlestick patterns may not be very useful. Instead, you may have to watch out for multiple candlestick patterns such as the following:
- Piercing line
- Morning star
- Bullish harami
- Bullish engulfing
You’ll recall that we’ve covered the above-mentioned multiple candlestick patterns in detail in our module titled ‘Introduction to Technical Analysis.’ These patterns indicate bullish reversal. Now, let’s quickly revisit them in the context of predicting the end of a bear market.
The piercing line is a dual candlestick pattern with the first candle being red and the next one being blue (or green). The second candle engulfs the first candle, although not entirely. If you refer to the arrow marked in the above image, you can clearly see the appearance of a piercing line pattern. Following this, the market trend immediately changes from bearish to bullish.
- Morning star
The morning star is a three candlestick pattern with the first candle being red, the second one being either red or blue, and the third candle being blue. The appearance of a morning star pattern is indicative of the end of a bearish trend. It is highly likely to turn the tides in the favour of bulls, as you can see in this image above.
- Bullish harami
The bullish harami is considered to be one of the most important bullish reversal patterns out there. It consists of a long red candle, followed immediately by a smaller blue candle. The body of the second candle, being small, should be contained completely within the body of the first red candle. Notice how it’s exactly like that in the picture above? And as you can see, the trend turns bullish with the appearance of the bullish harami pattern.
- Bullish Engulfing
The bullish engulfing pattern is another highly accurate candlestick pattern for investors seeking a bullish reversal. It is so powerful that it’s appearance almost always indicates the end of the bear market. The arrow marked in the above picture clearly depicts the bullish engulfing pattern and the way it completely sways the trend from bearish to bullish.
If you’re ever in need of more clarity on bullish reversal candlestick patterns, you could always go back and revisit our module on technical analysis. Now, let’s check out the next indicator - VIX.
2. Volatility Index (VIX)
VIX, also known as the Volatility Index, is an indicator of the level of volatility that exists in the market. The higher the VIX, the higher the volatility in the market. Though the VIX was introduced in the 1980s, the Indian version of it - India VIX, was announced only in 2008. Many traders and investors use the VIX to predict just how big or small the market movements are going to be in the near future.
Now, when a new trend, such as a bear market starts, the VIX is likely to go up. This signifies increased volatility, market participation, and large movements in the indices. As the bear market continues to go on, the VIX would also continue to move upwards, indicating increasing volatility. And when the VIX finally hits its peak, it is often construed as the peak of the bear market.
From there onwards, the VIX is likely to slowly decrease, indicating the loss in momentum of the bears. Traders and investors view the fall of the VIX from its peak as another indicator of the beginning of the end of the bear market.
3. Market conditions
Many traders and investors also use the current market conditions to predict the end of a bear market. While this might not be as accurate as the above two methods, it can give you a fair idea of where the bear market currently stands. For better results, you could even use it in conjunction with candlestick charts and the volatility index. That said, this technique is of use only if there’s a specific, identifiable cause for the bear market.
For instance, if the bear market was brought on by declining growth of companies and a bad earnings season, the bearish trend is likely to end once the companies start to grow at a healthy pace backed by a strong earnings season. If such a favourable event does happen, investor confidence is likely to be slowly restored, and the bearish trend would then reverse into a bullish one.
On the other hand, if the event doesn’t happen as intended, the bear market is likely to gather momentum and continue on for another few months. And so, by simply closely monitoring the market conditions, you can, to a certain extent, get a rough idea of the possible end of a bear market.
4. Economic indicators
The economic scenario of a country also plays a huge role in determining the course of the primary trend of the country’s stock markets. For instance, during the course of a bear market, if the economic conditions such as interest rates, inflation figures, GDP growth rate, and employment numbers, among others, see a marked improvement, then the bear market is likely to bottom out in the near future.
All said and done, when you’re trying to predict the end of a bear market using any one of the above mentioned methods, always keep in mind that you must beware of the bear market rally. Sometimes, what might seem like a bear market reversal might simply be the market undergoing a minor correction.
This minor market correction is what traders refer to as the bear market rally. During this rally, the stock prices and indexes will briefly go up for a while before continuing on with the prevailing bearish trend. So, it is always a good idea to confirm the reversal of the bear market before initiating any new positions.
And with this, we’re finally nearing the end of this module. In the next chapter, we’re going to be taking a look at some of the factors that end up causing bear markets. Stay tuned!
A quick recap
- No one can accurately predict the end of a bear market. The reason for this is that there are simply too many variables involved.
- That said, there are certain ways through which you can try to roughly estimate when the bear market is likely to bottom out and turn into a bull market.
- More specifically, there are four primary tools or indicators that you can use to estimate the end of a bear market.
- Of these four methods, technical analysis using candlestick charts is by far the most accurate way to predict the end of a bear market, if at all.
- Patterns like the piercing line, the morning star, the bullish harami and the bullish engulfing can be useful.
- Another indicator for the end of a bear market is VIX, also known as the Volatility Index.
- Furthermore, market conditions and economic indicators can also help you identify bullish reversals that may be fast approaching.