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How Does a Bear Market Differ from a Bull Market?
What makes studying financial markets so interesting is the psychology that drives them. After all, every buy order and sell order is based on where investors and traders think (or hope) the market will go. This behavior is not scientific – it's emotional. That's why markets are near-perfect barometers of overall social mood. Elliott wave analysis takes that psychology into account. Its most basic wave pattern (three waves up, two waves down) shows this psychology at work in the markets. Learning how to interpret those patterns takes time, but it pays off in knowing what is likely to happen as a bull market or a bear market take shape. In this Q and A, Bob Prechter talks about how to tell the difference between a bull and a bear market – and how to know when they are topping or bottoming.
Excerpted from Prechter's Perspective, re-issued 2004
Q: Advances and declines, bull and bear markets take different shapes. Is this also true of the psychology in bull and bear markets?
Bob Prechter: The problem with declines is that they can follow a lot more paths, because there are numerous corrective patterns [in Elliott wave analysis]. At the start of a bear market, all you have are hints. You have little certainty about which one of the shapes is going to take place. All you can say is it is going to be rough for a while. Bob Farrell says that a bear market goes from caution to concern to capitulation.
Bear markets tend to bring bad news in one form or another, regardless of their shape. Triangles, for instance, are seemingly moderate sideways patterns. Yet there is almost always a scary event or point of focus in wave e, the last wave, that keeps you out of the next advance. In a large bear market, wave e of an upward triangle correction usually features a bullish event that gets people to buy just before the rug is pulled. However, the worst news – the news that turns out making the history books – usually awaits the end of a large bear market. Bull markets do it again, only the other way around: they save the best news for last.
Q: Do the different psychologies of bull and bear markets show up in other non-Elliott areas, like momentum indicators?
Bob Prechter: Oh, yes, for instance, extreme overbought conditions generally indicate further advance until the overboughts become milder. By contrast, extreme oversold conditions often accompany the price low of a decline. Fear does not need a period of dissipation as does hope.
Q: So a technically strengthening upward thrust in stock prices is usually closer to a bottom than a top?
Bob Prechter: Acceleration into a top is typical of commodities but not of stocks. The stock market has always given plenty of warning from a momentum standpoint that a top was in the making. From December 1985 to March 1986, when the bull market of the 1980s was at its epicenter, all the talk of a "blowoff" was coming from the commodity futures traders who have less experience with the stock market than with commodities.
Stocks just don't blow off. If you throw a ball into the air, it has to slow down before it comes down. The market doesn't exactly follow the laws of physics, but its action does seem to reflect this one.
Even the 1929 high was accompanied by "top building," i.e., a glaring divergence in the 6-month percentage rate of change. As the great Dow Theorist Richard Russell says, "A blowoff is when the market goes up big, and you were bearish the whole rise." In other words, in the stock market, the idea is a psychological feeling more than a true description of a stock market chart formation.
Q: Does this slow topping process serve any function?
Bob Prechter: Many manias in history have outlasted the Cassandras to the end of devastating the finances of the largest possible number of people. The crowd is buying fantasies. That is why the professional who can measure the amount of emotional activity in a market and relate it to the degree of the wave in progress is going to make money. When fantasies get far out of line with reality, you've been presented with the opportunity to make money, whether it's on the downside or the upside.
Now That the Market Has Shifted, What Do I Do? Take time to subscribe to the Elliott Wave Financial Forecast. It will keep you ahead of the curve, so that you will feel more in control in the face of a bear market and a declining economy. The latest issue helps you to understand exactly what drives the changes and trends in financial markets, and how you can anticipate those changes. Read more here.
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