Bull Market Basics, Part One: The History And Signs Of A Bull Market

David Frost // Blog, How To Invest


February 19  

The financial media is sounding a lot like a broken record these days with all the stories about the current bull market, which is widely considered to be the longest one in history. A bull market is the opposite of a bear market. It’s when asset prices are generally on an uphill climb. This doesn’t mean that prices never fall during a bull market, but it does mean that the broad trend is up.

Since prices are climbing higher during a bull market, it may seem like it’s nearly impossible to lose money during one. However, while it is easier to make money during a bull market, there are still plenty of ways to miss opportunities if you haven’t spent time studying the market. Profiting during a bull market requires more than just plunking some money down and watching it grow. You also must be able to identify which areas of the market are likely to keep growing and then try to pick the best of the bunch.

Why is it called a bull market?

The most widely accepted explanation for why an up market is referred to as a bull market has to do with the way bulls attack, which is with an upward thrust of their horns. This differs from how bears attack, which is with a downward slash of their claws. However, this isn’t the only possible origin for the term.

Some point out that the term “bear” in reference to investors who expect prices to fall came before the use of the term “bull” to refer to those who expect prices to rise. As discussed in a previous article, the term “bear” was derived from sales of bearskins decades ago when traders would sell skins before the bears were actually caught.

These bears sold the skins for a certain price with an expected delivery date later. They expected the price to fall between when they sold the skins and when they purchased them, so they would turn a profit by selling at a higher price but buying later at a lower price. Identifying the bull as the opposite of the bear could be traced to a common blood sport from centuries ago when people would pit bulls against bears just to watch them fight.

How to recognize a bull market

Bull markets are easily recognizable by the strong sense of optimism that pervades the markets. Investors widely expect prices to keep going up, so it only seems natural that they do. It becomes a self-fulfilling prophecy because the more investors expect prices to rise, the more optimistic they become, and the more optimistic investors are, the more they are willing to buy. A key driver of rising prices during bull markets is demand. Since there are more buyers than sellers during such markets, the price increases because demand outstrips supply offered by sellers.

In order to technically qualify as a bull market, prices generally must rise by at least 20% from the recent low. This isn’t a hard and fast rule, but it is a general guideline that market watchers look for when trying to determine the state of the market. In most cases, the 20% increase must follow a period during which prices fell at least 20% off a previous high. The bull market’s 20% increase must then be followed by a down period in which prices fall at least 20%. Any increases or declines which are less than 20% are merely phases within the secular bull or bear market that’s going on at the time.

Bull markets generally last much longer than bear markets, which must last about two months in order to qualify as a bear market. To qualify as a secular bull market, it must last at least five years and could even last as long as 25 years. The current bull market started in March 2009 and is now the longest-running bull market. The previous record was set during the tech boom between 1990 and 2000.

What does the economy look like in a bull market?

The economy is usually strong or strengthening in a bull market because all that optimism has to come from somewhere. Investors become optimistic because of numerous indicators which show that the economy is in good shape. The nation’s gross domestic product is generally strong during a bull market, and unemployment declines while company profits increase.

Consumers appear more optimistic because they’re spending more money on discretionary items while saving less. They’re not worried about possibly losing their job or not having enough money to pay the bills. All this excess money is generally funneled into two places: the pockets of businesses and investment accounts. As businesses see more money flowing in from consumers, so their profits increase. As profits rise, investors are willing to pay more for their stocks because they are earning more money. It’s a broad cycle with each factor feeding into the next one.

While a bear market is going on, it can be difficult to see the light at the end of the proverbial tunnel. However, traders often watch various economic indicators for signs of life. Of course, the problem with this is that sometimes unemployment may fall one month but then go back to increasing the next month. Thus, a longer trend is needed for most investors to get more constructive on their investments at the tail end of a bear market. The more economic indicators which are positive, the more likely investors are to take up a more optimistic view of the markets.

Stock prices when the bulls are in control

Bull markets can affect the stock market, the gold market or other assets. Usually when traders talk about a general bull market, they’re referring to stocks. Sometimes certain sectors can be in a bull market, while other sectors may be stagnant or even in a bear market, depending on current events which are affecting the market and prices.

During a bull market, stocks in defensive sectors may not do as well as cyclical names because investors have a greater appetite for risk. They don’t feel the need to protect themselves and their investments because they just expect prices to keep rising. When stocks are in a bull market, gold prices tend to fall because demand is lower, and gold is a safe-haven investment which serves as a store of value during more difficult times. Demand for bonds may decline as well because investors are willing to take on more risk for the greater reward they can enjoy in the stock market.

The next article in this series will focus on the phases of bull markets.

About the Author

Trading and investing in markets is second nature to some, but a mystery to others. The goal is to provide a forum where everyday people aspiring to be part time or full time traders will learn how view markets differently and profit beyond their wildest dreams.

David Frost