Given all the talk and even quite a bit of concern about the threat of another bear market showing its ugly face soon, it pays to brush up on our skills on how to track a bear.
What goes up must come down isn’t really true about the stock market, but we can at least say what goes up might come down for a while. This while can last quite a while at times, or at least they have at various times throughout the history of stock markets, and we call these bear markets.
A bear hunts by using their powerful paws in a downward motion, which is thought to be the reason why we use the name of this animal to describe downward trends. Bulls attack upward with their horns, so we use that one to describe the upward trends.
The majority of people in the stock market, and the vast majority of investors, are rooting for the bulls and hate the bears. They place their bets on what we call the long side, by buying shares or other instruments that go up in value as the price of the stocks or the instrument rises in value, and lose money when the price goes down.
It’s not that money is won or lost until we exit a position, unless you trade futures where prices are settled at the end of each day, with the differences day over day get deposited or withdrawn from your account with your broker. With stocks, while we calculate the values of our position by way of the last trade, the only time money changes hands is when we buy and sell these securities.
This doesn’t mean that we shouldn’t be paying attention to these changing values even if we are planning on holding them right now, because even though we may prefer to hold on tight, we could exit at any time, and whether we want to now or not is always an open question.
What we really want to be measuring when we look at price trends isn’t how much we may be up or down in a position at the moment, it’s where things may be going from here and whether we should stay in them or not.
Staying on the Lookout for Bears
When we’re in a bull market, things are proceeding according to plan, as this is what we want to see and how we make money. When the bears start taking over more, we really need to be able to decide whether the move is deserving of our attention and action enough, and whether to hibernate during these cold winters.
This is not as easy of a task to pull off as it may appear, because of the different perspectives we can take when doing this, and the pullback in the last quarter of 2018 is a perfect example of this. For illustration purposes, we’ll use the S&P 500 as the benchmark, which represents a wide distribution of large U.S. stocks.
There are various ways to measure what may be going on in the stock market, but since it’s prices that we are concerned about, it only makes sense to use prices as the measuring stick. Certain things may suggest price trends, but since it’s price trends themselves that we’re after, there’s nothing like getting your information from the horse’s mouth by looking at charts.
There are a lot of different ways to measure these things, but all look to decide whether one trend is over and another one begins. Nothing moves in a straight line here, and no matter what time frame you look at, you will see rises and dips of various magnitudes and durations.
We could draw an upward trendline at the lows of February and October of 2016 and extend that upward and use this as a tool, This would have us staying in through the first major pullback along the road in the first quarter of 2018, because the price stayed above this line, but would have us out in mid-October that same year, when we did break through. The trendline that emerged with this move down was a sharp and we broke back through it in January 2019, and we’ve been in a clear trend up since.
This is just a simple example of some of the tools that can be used by investors to take the temperature of the market to see who is in control at any given point in time. It can get a lot more complicated than this of course, but investors need to stick to the pretty simple stuff, and trendlines are an example of a signal that provides relative simplicity.
Major Bull and Bear Trends are Not That Difficult to Spot
We can go further back than this to show how trendlines can be used by longer-term investors, right back to the start of this current bull market in 2009. Even the 2018 bearish move didn’t quite break this one, even though it almost did, but another one right now of that magnitude would. Going much below that would indeed be pretty bearish, because this would mean that this current rally is transitory and the overall move is in the other direction.
Trendlines can be used by anyone from minute to minute traders to longer-term investors, and this last one has us staying in for 10 years so that’s longer-term for sure. This could continue on for a few more years in fact, as we still have quite a bit of leeway here and we’d need to see a significant drop for this line to be broken.
If things really do go south though, we should really want to have some sort of exit plan, lest we expose ourselves to whatever may happen, which includes real crashes where things go down 50% or even up to 80% with the worst ones. The 80% was during the Great Depression, and while we may never see anything quite like that again, the 21st Century has already showed us two of these over 50’s.
While the current 10-year bull trend has been pretty impressive, we had one that lasted almost twice as long during the period between 1982-2000. Using a trendline would keep us in all this time and have us heading for the exits about 6 months into the bear reversal, with a tidy profit indeed.
Investors don’t really play the short side very often, but a trader would look to capitalize on both the down trends and the up ones, but investors still need to seek to measure both even if they are flat and waiting for another reversal, because we need to know when it is time to get back in.
The rationale here is that, while the market zigs and zags a lot, we want to know whether it is primarily zigging up or zagging down. There is no crystal ball here or formula that you can use to be on the right side of things all the time, but going with the major trends is at least going to keep you on the right side of things more often than not, and therefore have you keeping more of your gains from bulls and not have yourselves getting swatted down by bears so much.
We can even just look at a long-term chart of the S&P, which is the length of chart that investors who are in for a period of years need to be looking at, and at a glance we can see how these battles between the bulls and the bears played out over time, where it should be fairly easy to notice who was in control during various eras.
Even if this is the extent of our analysis, just looking at a longer-term chart from time to time, we at least have a plan. As it turns out, this is surprisingly effective and clearly better than the just close your eyes and hope strategy. The most important thing though is to not use something that generates way more signals than we would ever want to trade as investors, forcing us to trade instead of invest which requires considerably more skill.
This is also not a matter of assigning some arbitrary holding time such as a couple of years or 10 years or more. We do need to decide on time horizon, but this means we’ll look at charts that extend out more if we are longer, and shorter ones if we want to move in and out more often, like ones that only last a few years.
If we just look at the chart for the last year for instance, we see a few trends there, but unless we are shooting to trade several times a year, this will do us no good and actually force us to do that if we are going to execute such a plan.
Stock markets do go up over time, but they also go down quite a bit along the way, and keeping your eyes out for the bears is a wise thing to do. We just need to make sure it’s the real bears and not just the cubs that we are running away from.