Bear market rally are difficult to understand for unprofessional investors, and even for some professional investors. I've been studying the action and reaction of the bear market for the past few months with some thoughts to share.
Bear market action is a primary down trend (sell-off). By contrast, reaction is a reversal of a down trend (rally). Novice investors asked how is it possible that we have a rally in a bear market? There's no single explanation to that answer but I've come up with some qualitative reasoning behind the rally.
Bear market action is a primary down trend (sell-off). By contrast, reaction is a reversal of a down trend (rally). Novice investors asked how is it possible that we have a rally in a bear market? There's no single explanation to that answer but I've come up with some qualitative reasoning behind the rally.
Primary Sell-off
During the market sell-off, economic and earning data are bad. Often time the data accelerate downward creating momentum selling to occur, creating primary sell-off.
Secondary Rally
At some point, that acceleration has to stop or slow down. Those who have been shorting the market cover their shorts by buying back the stocks, creating buying pressure. The key catalyst is the deceleration in bad data. Statistically, nothing accelerate at constant or at faster pace forever thus any slowing may perceive as "better" situation. Trader and investor sense that things can't get worse and as a result, they buy. This create a secondary rally.
Resume Sell-off
The next question you should ask yourselves is, will the economic data continue to improve? Will the data level-off or contract again? Stocks can move rather quickly in both directions so you have to make a judgment call whether the stock overshoot the real economic growth or not. If the economic activity level-off, that catalyst of growth is taken away and selling may resume.
Current situation
Things appear to be less bad. Unemployment rate is slowing, and yet still rising. Foreclosure ratie is slowing, and yet still rising. Could we be in a secondary reactions stage where things appear to be less bad? We won't know until after the fact. The next few quarters will be a true testimony to the bull because we are going to see if economic data can continue to improve.
Traders trade based on statistics by comparing downside risk to upside risk. Economic data are just statistics. Investors buy based on value. So don't let statistic play tricks on you.
Art
During the market sell-off, economic and earning data are bad. Often time the data accelerate downward creating momentum selling to occur, creating primary sell-off.
Secondary Rally
At some point, that acceleration has to stop or slow down. Those who have been shorting the market cover their shorts by buying back the stocks, creating buying pressure. The key catalyst is the deceleration in bad data. Statistically, nothing accelerate at constant or at faster pace forever thus any slowing may perceive as "better" situation. Trader and investor sense that things can't get worse and as a result, they buy. This create a secondary rally.
Resume Sell-off
The next question you should ask yourselves is, will the economic data continue to improve? Will the data level-off or contract again? Stocks can move rather quickly in both directions so you have to make a judgment call whether the stock overshoot the real economic growth or not. If the economic activity level-off, that catalyst of growth is taken away and selling may resume.
Current situation
Things appear to be less bad. Unemployment rate is slowing, and yet still rising. Foreclosure ratie is slowing, and yet still rising. Could we be in a secondary reactions stage where things appear to be less bad? We won't know until after the fact. The next few quarters will be a true testimony to the bull because we are going to see if economic data can continue to improve.
Traders trade based on statistics by comparing downside risk to upside risk. Economic data are just statistics. Investors buy based on value. So don't let statistic play tricks on you.
Art
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