Three phases of a bear market

By | May 12, 2009

Many investors may be confused whether the current stock market rally
is a bear market rally or a bull market rally. The fund managers have
voted for the bulls, while the economists are distinctly bearish. The
fund managers may have a vested interest in market movements. The
economists supposedly do not – but neither do they bet millions of
dollars in the stock market.

So I thought it may be worthwhile to revisit what the technical
analysts’ “Bible” has to say about bear markets:-

The Bear Market—Primary downtrends are also usually (but again, not
invariably) characterized by three phases. The first is the
distribution period (which really starts in the later stages of the
preceding Bull Market). During this phase, farsighted investors sense
the fact that business earnings have reached an abnormal height and
unload their holdings at an increasing pace. Trading volume is still
high though tending to diminish on rallies, and the “public” is still
active but beginning to show signs of frustration as hoped-for profits
fade away.

The second phase is the panic phase. Buyers begin to thin out and
sellers become more urgent; the downward trend of prices suddenly
accelerates into an almost vertical drop, while volume mounts to
climactic proportions. After the panic phase (which usually runs too
far relative to then-existing business conditions), there may be a
fairly long Secondary recovery or a sidewise movement, and then the
third phase begins. This is characterized by discouraged selling on
the part of those investors who held on through the panic or, perhaps,
bought during it because stocks looked cheap in comparison with prices
which had ruled a few months earlier. The business news now begins to
deteriorate.

As the third phase proceeds, the downward movement is less rapid, but
is maintained by more and more distress selling from those who have to
raise cash for other needs. The “cats and dogs” may lose practically
all their previous Bull advance in the first two phases. Better grade
stocks decline more gradually, because their owners cling to them to
the last, and the final stage of a Bear Market, in consequence, is
frequently concentrated in such issues.
The Bear Market ends when everything in the way of possible bad news,
the worst to be expected, has been discounted, and it is usually over
before all the bad news is “out.”

The reader should be warned, however, that no two Bear Markets are
exactly alike, and neither are any two Bull Markets. Some may lack one
or another of the three typical
phases. A few Major advances have passed from the first to the third
stage with only a very brief and rapid intervening markup. A few short
Bear Markets have developed no marked panic phase and others have
ended with it, as in April 1939.

(from Technical Analysis of Stock Trends by Edwards & Magee)

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