Bear Markets Do Have Sharp Rallies

Commonly, I find that investors are very fickle people, especially those who have just started out investing their own money. They want to play the momentum of the stock market and they are often hurt by too many momentum trades that don't work out the way they had hoped. A major example of this is bear market rallies, which are extremely common, but continue to sucker a lot of people into losing money in their investment portfolio.

Many people seem to believe that during a bear market stocks go straight down and up days simply aren't present, or if they are they will be very small up days. In fact the past tells us that some of the biggest up days in the stock market's history are during the worst of the bear market periods. Did that necessarily mean that it was time to buy and get bullish right away? No, it simply meant that for a short time the bulls had the momentum on their side for one reason or another.

What are the major causes of strong bear market rallies? One of the biggest causes is the fact that so many people are short sellers in a bear market and they cover their shorts as the market rises, and it exaggerates the move to the upside. Overall the main reason for the huge volatility and huge moves to the upside is the uncertainty in the stock markets. Rather than a steady slow increase over time as is common with bull markets, bear market rallies are generally extremely sharp, but very short-lived as well.

Eventually bear market rallies turn into the bottom for stocks, but many investors are haunted by the mistakes that they are unable to learn from, which all deal with chasing false rallies. This is the main reason these types of rallies are often called "suckers rallies."

How can an investor tell when it is a false bear market rally and when it is actually a bottom in the bear market swoon? The truth is there is no single way that can tell you this other than waiting on the market to tell you. There are a couple clues that can help guide you, which include the performance of the market after a major up move. For example, if the market loses 3/4 of its gains within three or four trading days, things are not looking good at all for the sustainability of the rally. On the other hand if the market continues to hold its gains and even build on them slightly, while having heavy buying volume, this can be a sign that the bottom could be in. Heavy volume on turnaround days can be quite important.

It is a myth that bear markets cannot have sharp rallies, so make sure you understand that when you are making your investment decisions.