The Psychology of Bear Markets

Are we in a bear market yet? Not as of yesterday, but possibly as of tomorrow’s close, which will mark the end of the month. Both weekly and monthly closes are carefully watched by hedge funds and institutions, respectively.

In simple technical terms, a bear market will begin if the S&P 500 (SPY) closes below the 13-ema on a monthly chart, with a broken multi-year uptrend line. For “confirmation,” the 13 ema needs to cross down below the broken trendline. You can see these simple patterns clearly on the accompanying chart that shows the last two bear markets.

With AAPL headed to $75, I firmly believe that the S&P 500 will enter a technical bear market in February and it will confirmed in March or April. Bear markets last 18-30 months on average, so investors should plan on a challenging 2016 at the very least. If it is of the Uber Ursa variety, however, which means it is being fueled by a global recession with deflation, then it could last even longer: possibly 3-4 years. That’s what I’m expecting.

The psychology of bear markets is the opposite of what you have grown accustomed to over the last 6 years. Bull markets rise on the heels of sharp, scary washouts that don’t last very long. Bear markets fall on an extended “slope of hope.”

I had the “pleasure” of running trading services during the last two bear markets. The tricky thing about bear markets is that they generate the largest rallies you will ever see. But those rallies don’t signal a trend change.

Therefore, once the bear market starts, it’s vitally important for individual investors to give up hope as soon as possible. That’s the only way you can protect yourself psychologically. Hope is the enemy of prudent investing. If you notice you have the symptoms of hope, go see a portfolio surgeon immediately and get it removed.   

Once that mental-emotional parasite is expunged, you have a chance to think clearly and evaluate options for profiting from the downtrend.

www.daytradingpsychology.com (Coaching for private traders.)

www.trader-analytics.com (Peak performance consulting to RIAs, hedge funds and banks.)

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