Bull and bear markets, and why the labels arrive late

Two words get used constantly and defined rarely. Both describe a direction that has already happened, which is the part that matters and the part usually left out.

The convention

A bear market is commonly defined as a fall of twenty percent or more from a recent high. A bull market is the sustained rise that follows one. A fall of ten percent is usually called a correction.

That twenty percent figure is a convention, not a law. No regulator sets it and nothing happens when it is crossed. It is a round number that became standard through repetition in financial media, and it is applied to indexes far more often than to individual companies, where twenty percent moves are ordinary.

The labels arrive after the event

Here is the part that matters for anyone trading. A twenty percent fall can only be measured once it has happened. By the time a decline is called a bear market, the twenty percent is gone.

The same is true in reverse. A bull market is named after a substantial rise is already in the price. The label is a description of the recent past wearing the grammar of the present, which is what makes it feel like information when it is mostly history.

This is worth internalising early, because a great deal of financial media consists of labels being applied to moves that already finished, delivered with the urgency of news.

What actually changes

The label is retrospective. The conditions it describes are real, and some of them are measurable while they are happening.

Volatility

Falling markets are typically more volatile than rising ones. Daily ranges widen, and moves in both directions get larger. A position sized comfortably in a calm market can be uncomfortably large in a volatile one without the share count changing at all.

Correlation

In a sharp decline, things that normally move independently start moving together. Diversification across companies helps less than usual at exactly the moment you want it most, because what is being sold is exposure in general rather than any particular company.

Liquidity

Spreads widen and depth thins in stressed markets. The cost of entering and leaving rises, and market orders become more expensive in precisely the conditions where people are most tempted to use them.

Sharp rallies inside declines

Some of the largest single day rises on record happened during severe declines. A violent rally is not evidence that a decline has ended, and treating one as a signal is a well documented way to lose money during a downtrend.

The bear market rally, and why it is so convincing

Sustained declines are not straight lines. They contain rallies, and those rallies are frequently sharper than anything seen in a calm rising market.

The reason is mechanical rather than psychological. In a decline, short positions accumulate. Any bounce forces some of them to close, and closing a short means buying, which accelerates the bounce. Add participants who have been waiting for a lower entry and the result is a violent move up inside a downtrend.

These are convincing precisely because they are strong. A rise of ten percent in a few days feels like a turn. Historically, a great many such moves occurred during declines that had considerably further to run.

Nothing here says a rally must fail. The point is narrower: the strength of a rally is not evidence about whether the decline has ended, because the mechanism that produces the strongest rallies is a feature of declines.

Where the stress actually shows first

Since the label is retrospective, the useful skill is reading conditions while they happen. Several are observable without forecasting anything.

• Range expansion. The distance between a day high and low widening, consistently, across many names.
• Correlation rising. Unrelated companies moving together, which says participants are trading exposure rather than businesses.
• Spreads widening. The cost of entering and leaving rising, visible on every ticket you place.
• Volume on down days exceeding volume on up days, sustained over weeks.

All four are measurements of the present. None of them predicts anything. What they do is tell you the environment your position is sitting in, which is the input to how large that position should be.

What does not change

The mechanics are identical. The book works the same way. Order types behave the same way. The relationship between expectations and price is unchanged. A stop is still a trigger, and a market order still buys the ask.

What changes is the size of the numbers those mechanics produce. Which is why risk per trade, covered later in this series, is the thing that determines whether a volatile stretch is survivable rather than any view about direction.

The arithmetic of a drawdown

This is the most useful number in the piece and it is pure arithmetic, with no forecast in it.

A fall and the rise needed to undo it are not symmetrical. Down twenty percent needs twenty five percent to get back. Down thirty-three percent needs fifty. Down fifty percent needs one hundred. Down eighty percent needs four hundred.

• lose 10 percent, need 11.1 percent to recover
• lose 20 percent, need 25 percent
• lose 33 percent, need 50 percent
• lose 50 percent, need 100 percent
• lose 75 percent, need 300 percent

The reason is that the percentage gain is calculated on the smaller remaining balance. Nothing about it is a market opinion, and it is why capital preservation is not timidity. A trader who avoids the deep drawdown needs a far smaller subsequent gain to be whole.

This arithmetic is also why position sizing matters more than entry timing, which is a claim that sounds like folklore until you see the table above.

Where the words came from

The usual explanation is the way each animal attacks. A bull drives its horns upward, a bear swipes its paws down. There is an older story about bearskin traders selling hides they did not yet own, which is a description of short selling and may be the actual origin.

The etymology carries no information about markets. It is included because the question comes up constantly, and because knowing that the labels are old folk metaphors is a small inoculation against treating them as technical terms.

Rotation, and why an index hides what is happening underneath

An index is an average, and averages conceal. A market can drift sideways for months while money moves steadily from one kind of company to another, and the index reports almost nothing.

The common framing is cyclical against defensive. Cyclical businesses, whose earnings track the economy closely, tend to be favoured when growth expectations rise. Defensive businesses, selling things people buy regardless, tend to hold up better when expectations fall.

The practical point is narrower than it sounds. A flat index does not mean a quiet market, and a company can be in its own severe decline while the average looks calm. Judging your position by the index is judging it by a number that may not describe it.

Recovery takes time, and the time varies enormously

Declines and recoveries have historically differed wildly in length. Some deep falls have been recovered within months. Others have taken years, and a handful of severe ones have taken more than a decade to regain a prior peak.

No pattern in that history tells you the duration of any future episode, and anyone presenting an average recovery time as a plan is offering a forecast dressed as data. The useful conclusion is about your own timeframe: money you need soon and money you can leave alone are different money, and a decline treats them very differently.

On predictions

Nothing in this piece, and nothing anywhere on this site, forecasts which of these conditions is coming. People with far more information than a trading room get this wrong routinely, and confident calls about market direction are worth treating as entertainment.

What is useful is preparation that does not depend on being right: knowing your risk per trade, knowing that correlation rises when it hurts, and knowing that your position size is really a volatility decision.

How the Den uses this

The rooms talk about conditions rather than regimes. Whether ranges are widening. Whether names are moving together. Whether liquidity is thinner than usual. Those are observable now, and they change how a trade is sized today.

You will not see a call in the rooms for the start or end of a bear market, and that is a house rule rather than an oversight. A call like that cannot be acted on with a defined risk, and anything that cannot be given a stop does not belong in an alert.

What you will see, when conditions get rough, is smaller size and more written up losses. The post mortem room gets busier in volatile stretches, which is exactly when it is most worth reading. A loss explained in a hard market teaches more than a win in an easy one.