As an investor it can be tough to control your emotions in a volatile market, but those who are unable to do so can suffer greatly. During a bear market there are many emotions going around Wall Street, and a bear market rally can make everyone feel as if things are all better in an instant. An investor should tread very carefully during a bear market, and bear market rallies can be the most dangerous of all.
In fact during the current bear market that started in early 2008 there have been a total of four bear market rallies that have all failed. So why is the current rally any different?
Bulls argue that bank earnings are back up and TARP money is being paid off, things can only continue to improve. Bears on the other hand feel the deteriorating economy still has some ways to go and a recovery will not be seen by late 2009 as predicted.
There are 5 Reasons to Doubt Bear Market Rallies:
- There are often many of them – The fact is, there are a whole lot of bear market rallies during a typical bear market. Stocks are often shot higher for a very short time and then reality quickly sets back in. If you are quick to chase every bear market rally your head will likely be spinning from trying to chase stocks constantly in the down market.
- Rallies happen when fundamentals change - Have the fundamentals of the stock market or the economy changed? If the answer is no then you should strongly doubt a bear market rally, because it will likely be very short lived. In the long run the fundamentals of the economy will drive stocks and many bear market rallies have nothing to do with the fundamentals of the economy.
- Time is on your side – Time is definitely on your side when it comes to waiting out bear market rallies. Looking back historically there is no doubt that an investor is wiser to wait on the market to start back into a bull mode before buying in. You will have to pay slightly higher prices, but the risks are still much lower than they are by going all in during a bear market move.
- Short sellers are covering – Just as a down day happens because of investors taking profit during a bull market; the same is true in a bear market. Short sellers have made a large amount of money during bear market weakness and at some point they will want to cover and lock in those healthy gains.
- Optimism may be too high – As an informed investor if you hear too many television talking heads calling a market bottom and saying this is the real deal, you should be very cautious about believing that this is the real thing. Bear market rallies often pick up numerous suckers who believe this is the bottom, and until pessimism reaches very low levels the bear market is usually still intact.
The bottom line is that you would be wise to be very cautious about buying into a bear market rally. Keep your emotions in check and remember that you will have plenty more chances to buy the stocks you wish to purchase.
Aaron K. Smith is a freelance writer with experience working in the mutual fund industry and writing about investing and the stock market. View all posts by Aaron.
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