The 10 Key Differences Between Bull and Bear Rallies

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http://tradesystemguru.com/content/blogcategory/23/53/

1. Learn to instantly recognize cyclical versus secular trends on any stock chart. Cyclical bulls and bears are much shorter-term compared to a secular market bull or bear. At the other end of the scale are the powerful but brief one-day sucker’s rallies. Those with short investment time horizons can still make money buying stocks during a cyclical bull within a secular bear market. However, cyclical bulls can be very expensive for those without clearly defined exit strategies. No matter what your time horizon, it’s important to be aware of the prevailing secular and cyclical trends and trade accordingly. Overstaying your welcome in a trade during a cyclical trend can be very costly for those who get it wrong when the secular trend resumes.

2. Short-term bear market rallies are much more powerful than shorter-term bull rallies. Relief rallies are extremely powerful and why selling short can be so dangerous. This is one big reason why traders such as Dan Zanger prefer long trades.

“You can make money in both bull and bear rallies, but it’s a lot tougher in bear markets. It’s important to remember that the max you can make shorting a stock is 100% and that is only if the stock goes to zero. You have a limited upside but unlimited risk if the trade goes against you,” opines Zanger. “But you can make thousands of percent during a strong bull rally and unless you’re trading on margin, the max you can lose is what you paid for the stock in the unlikely event that it goes bust.”

3. Relief rallies in bear markets generally lack follow through. This point is a subset of point 2. Unlike bull market rallies, powerful bear rallies are often followed by ugly down days. In other words, buying into a big bear rally can be even more expensive than trying to catch a falling knife, the dangerous habit of buying during a big correction. So even if you do make money initially buying a bear rally, the gain can become a loss in short order.

4. Buying volume is higher on up days in a bull rally. In a bear rally volume is higher on the down days. This is one way that a trader who’s been away from the market can quickly tell which kind of market he is in. Stock rises tend to occur on falling volume in a bear rally. If volume falls during an up move, it often signals that the rise is nearing an end. Don’t get caught.

5. Bullish pattern failures are more frequent in bear rallies. According to Zanger, a pattern failure can often be a powerful signal to reverse direction. He provides a detailed description of the most powerful chart patterns such as cup & handles, head & shoulders, flag and pennants and parabolic curves at http://www.chartpattern.com/understanding_chart_patterns.html If you are in a long trade and there is a pattern failure, it is an exit warning. Cyclical chart patterns also tend to have a shorter duration than the same patterns occurring in a secular market.

6. Market sentiment responds differently in bull and bear markets. Bull markets climb the proverbial wall of worry. Both bullish and bearish sentiment tends to be more muted with euphoria usually only occurring near the end of the move. Bear markets on the other hand, slide down the slope of hope and are generally accompanied by extreme highs in sentiment followed by extreme lows (highs in bearish sentiment) which is another reason why volatility is higher during bear markets. Hope is one big reason why relief rallies can be so powerful. Pent-up investor optimism causes investors to pile into stocks on positive news, whether it is real or perceived.

7. Volatility is higher during bear rallies. Large shifts in sentiment aren’t the only reason for increased volatility during bear markets. As we have witnessed in the last four years, there are a number of other factors. Institutional traders must quickly react to big swings by unloading large positions. Governments also get involved in markets, especially around election time, making changes in monetary policy that can have a large impact on stock prices like we saw on November 30, 2011 when central banks led by the Federal Reserve announced that it was opening the discount window to European banks. This was perceived as good news and caused the huge spike in stock prices.

8. Short squeezes occur more often and are more powerful during bear markets. This is one big reason that shorting can be so dangerous. A short squeeze occurs when those who have borrowed a stock to sell short get caught when unexpectedly good news temporarily propels the price higher. Those with short positions scramble to cover (buy back) their short positions and in the process help propel the stock price even higher. Unfortunately for these shorts, the price usually hits their selling target but only after they have been forced out of the trade.

9. Leadership isn’t clear during a bear market rally. Different stocks generally lead the next bull market than did during the last bull. During the tech bubble in the 1990s, Internet stocks were the dominant leaders but financials led the next bull rally in 2003. Changing leadership is further confirmation that a new bull rally has begun according to Zanger. However, if leaders are defensive stocks such as utilities, it usually indicates a countertrend rally, which is a shorter-term rally in the opposite direction of the larger trend.

10. If a rally is occurring below a previous high, it’s either a bear rally or cyclical bull until proven otherwise. A new secular bull trend in U.S. stocks in real terms won’t be confirmed until the S&P500 breaks well above the 2000 high of 1527 and the longer that takes to occur, the higher the confirmation threshold will be. Until that time, any rally will simply be a cyclical bull rally.

Putting It All Together

It is a key requirement that to be successful traders must learn to differentiate between moves that are potentially profitable and those that aren’t. Zanger relies on his stock market leaders to help him decide when the time is right to buy. He then uses chart patterns and volume to help him confirm the trade and then tell him when it’s time to get out. Assessing the strength and duration of the current rally is an essential requirement.