The 20% Rule and Stocks Bear Markets

By: Michael_Swanson

From its July intraday low to its October 9, 2007 intraday high the DOW has fallen 20.5%. A lot of commentators on television and the Internet are making note of the fact that the DOW is down 20% and saying that this is "bear market territory." Some are saying that this means it is the time to buy, while others are saying this is proof that we are now in a bear market.

I don't really believe this is a good way to define a bear market. But let's take a look at some figures first before I get to that. First of all according to a story in this week's Barrons citing research by the Bespoke Group, there have been 11 bear markets since 1940. The average bear market last 386 days while the shortest, which took place in 1987, lasted only 101 days. They list the longest one being the 1973-1974 bear market, which they say lasted 630 days.

However, they divide the 2000-2002 bear market into two bear markets. I really think it was one big bear market. If you think like I do then you'll get a bear market that lasted for over 700 days.

What is interesting though is that the average bear market brought a 30.40% drop in the broad market averages. Historically once the 20% mark has been reached the best performing sector for the rest of the bear market has been gold stocks and as the bear market reaches an end the defensive sectors that usually do well in the beginning of a bear market end up dropping too.

I really don't like to use this 20% mark as a definition of a bear market, because once you get to 20% usually at least half of the bear market has already taken place - and even if it doesn't have more to go - if you wait for the market to fall 20% to decide you are in a bear market you are going to lose a lot of money getting to that 20% mark.

What I use to define whether or not a market is in a bear market is simple stage analysis. I break the market up into four stages - basing, bull market, topping, and then bear market. The market went through a topping stage in the first half of last year and began a bear market in the Fall. Gold and oil stocks never began a bear market and are still in bull markets while bonds appear to be in a topping stage.

It isn't hard to identify what stage a market is in.

The simplest way is just to look at the market in relationship to its long-term 150 and 200-day moving averages. Once the market breaks below them and stays below them for 6-8 weeks these moving almost always turn down. A bear market then begins and throughout the duration of the bear market these moving averages become resistance throughout the rest of the bear market.

We have seen this happen once again in this bear market. Back in November the S&P 500 rallied to its 200-day moving average and failed to breakout into a sustainable rally above them and turned lower. The same thing happened again this past May.

These moving averages will continue to act as key resistance points during this bear market. As you can see the market has fallen even further below them the past few weeks. Falling prices are only one component of a bear market. It will take a long time before the key market averages are able to have a sustainable rally above them and we'll have a bull market in which these moving averages will act as support. Even if the market were to bottom right now it would takes months of basing and sideways action before this can happen.

There is absolutely no reason to try to bottom guess this market. Rallies should be used to to raise cash and take short positions if you want to profit from the declines. It is best to wait until the end of the bear market before trying to buy into it. And of course there are indicators you can follow to warn you of a change in the market well before the moving averages do. None of them suggest that this bear market is over.

This article is an excerpt from a WallStreetWindow subscription article. To receive my stock picks and all future articles just click here .

By Michael Swanson
WallStreetWindow.com

Mike Swanson is the founder and chief editor of WallStreetWindow. He began investing and trading in 1997 and achieved a return in excess of 800% from 1997 to 2001. In 2002 he won second place in the 2002 Robbins Trading Contest and ran a hedge fund from 2003 to 2006 that generated a return of over 78% for its investors during that time frame. In 2005 out of 3,621 hedge funds tracked by HedgeFund.Net only 35 other funds had a better return that year. Mike holds a Masters Degree in history from the University of Virginia and has a knowledge of the history and political economy of the United States and the world financial markets. Besides writing about financial matters he is also working on a history of the state of Virginia. To subscribe to his free stock market newsletter click here .

Copyright © 2008 Michael Swanson - All Rights Reserved.

Disclaimer -

WallStreetWindow.com is owned by Timingwallstreet, Inc of which Michael Swanson is President and sole shareholder. Both Swanson and employees and associates of Timingwallstreet, Inc. may have a position in securities which are mentioned on any of the websites or commentaries published by TimingWallStreet or any of its services and may sell or close such positions at any moment and without warning. Under no circumstances should the information received from TimingWallStreet represent a recommendation to buy, sell, or hold any security. TimingWallStreet contains the opinions of Swanson and and other financial writers and commentators. Neither Swanson, nor TimingWallstreet, Inc. provide individual investment advice and will not advise you personally concerning the nature, potential, value, or of any particular stock or investment strategy. To the extent that any of the information contained on any TimingWallStreet publications may be deemed investment advice, such information is impersonal and not tailored to the investment needs of any specific person. Past results of TimingWallStreet, Michael Swanson or other financial authors are not necessarily indicative of future performance.

TimingWallStreet does not represent the accuracy nor does it warranty the accuracy, completeness or timeliness of the statements published on its web sites, its email alerts, podcats, or other media. The information provided should therefore be used as a basis for continued, independent research into a security referenced on TimingWallStreet so that the reader forms his or her own opinion regarding any investment in a security published on any TimingWallStreet of media outlets or services. The reader therefore agrees that he or she alone bears complete responsibility for their own investment research and decisions. We are not and do not represent ourselves to be a registered investment adviser or advisory firm or company. You should consult a qualified financial advisor or stock broker before making any investment decision and to help you evaluate any information you may receive from TimingWallstreet.

Consequently, the reader understands and agrees that by using any of TimingWallStreet services, either directly or indirectly, TimingWallStreet, Inc. shall not be liable to anyone for any loss, injury or damage resulting from the use of or information attained from TimingWallStreet.

© 2005-2022 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.