Bull Markets, Explained

By Rebecca Lake · March 17, 2023 · 7 minute read

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Bull Markets, Explained

A bull market occurs when a broad market index rises at least 20% over two months or more. Bull markets signal higher levels of investor confidence and optimism about the future of the market. They are generally a sign of a strong, healthy economy.

The opposite scenario, in which stock prices fall by 20% over an extended period, is known as a bear market.

If you’re investing in the stock market, it’s important to know the nature of bull markets and their potential impact on your returns.

What Is a Bull Market?

When asset prices generally rise over time, the upward trend is known as a bull market. The traditional benchmark for identifying a bull market is an increase of 20% or more in a market index over a two-month period. For example, stock experts might look closely at the Dow Jones Industrial Average (DJIA) or the S&P 500 to determine whether a bull market exists.

Bull markets can imply that the economy is in good shape, with unemployment low and new jobs being created. Investors tend to view a bull market favorably because it suggests that stock prices may continue to rise over the long term. People who buy stocks early in a bull market may benefit later from the investments’ significant price appreciation.

Why Is It Called a Bull Market?

Although there’s no single explanation for how bull and bear markets got their names, people often suggest that the descriptive names are meant to reflect the nature of each animal.

Bulls, for instance, have a reputation for charging or attacking. In a bull market, eager investors may rush in to buy stocks in the hope of capitalizing on future price increases.

Bears, on the other hand, are often seen as being defensive animals that only attack when threatened. In a bear market, it’s common to see investors pull back out of caution and sell off stocks they own or avoid buying new ones. Those behaviors are often driven by fear and uncertainty about the market trending down.

Characteristics of a Bull Market

Identifying when a bull market begins or ends is sometimes challenging, given the nature of stock prices and how rapidly they can move up or down. Generally, there are three indicators that stock experts use to determine whether a bull market exists.

•   Stock prices, or prices for a broad market index, have increased by 20% or more over a set period of time, typically two months or longer.

•   Investor confidence is high and those buying into the market have an optimistic outlook toward the future.

•   Overall economic conditions are largely positive, with low unemployment rates and, ideally, low inflation rates as well.

These three signs usually indicate that the market is on a sustained upswing. Other indications of a bull market can include strong earnings reports and marked increases in investors’ dividends.

What Causes a Bull Market?

Bull markets are usually driven by changing undercurrents in the economy. They tend to reflect the business cycle.

The business cycle experiences periods of expansion, followed by periods of contraction. Real gross domestic product is a commonly used metric for determining which of four phases the economy is in.

•   Expansion. During the expansion period, the economy is growing and domestic production is up. There may be a bull market for stocks during this period.

•   Peak. A peak occurs when the economy exhausts its ability to grow. At this stage, the bull market typically hits its highest levels before entering the next phase.

•   Contraction. During the contraction period, the economy shrinks. Companies may cut back on spending or hiring to save money and stocks may enter bear market territory.

•   Trough. The trough is the lowest point in the business cycle. It’s followed by the beginning of the next expansion phase, which can open the door to a new bull market.

The business cycle also influences when bear markets occur. In addition, there are times when a bull or bear market is triggered by something other than the business cycle. For example, in early 2020 there was a short-lived bear market caused by uncertainty over the emerging COVID-19 pandemic.

Example of a Bull Market

The bull market that began in 2009 following the shock of the financial crisis is the longest on record, lasting until the bear market that occurred in early 2020.

Several factors contributed to the sustained length of the bull market, including strategic moves to manage monetary policy on the part of the Federal Reserve, and tax breaks delivered by the 2017 Tax Cuts and Jobs Act.

Many stockholders benefited from steady dividend payouts, and the real estate market also delivered a strong performance during that time.

Bull Market vs Bear Market

Bull markets and bear markets are opposites in terms of how participants behave and what the outcomes can mean for investors. Bull markets typically involve upward movement of stock prices while bear markets indicate a downturn.

In a bull market, investors tend to take a positive view of the market. Bear markets, on the other hand, can trigger pessimism, fear, or other negative feelings among investors.

Bull markets are usually marked by thriving economies and high levels of corporate growth. Bear markets point toward a slowing economy and limited growth. In extreme cases, a bear market could suggest that a recession may be on the horizon (although a recession can offer certain opportunities as well).

Investing Tips During a Bull Market

Investing in a bull market isn’t one-size-fits-all, so your personal approach may be different from other investors’. There are, however, a few overall strategies that could help you to maximize gains while taking on a level of risk you’re comfortable with.

Keep Your Goals In Sight

It’s easy to be tempted to follow the crowd when investing in a bull market or a bear market, but it’s important to stay focused on your individual goals, especially if you’re a beginning investor. If you already have a financial plan in place, that plan can act as a guide for how to choose the right asset allocation during a bull market.

Diversify Your Portfolio

Diversification is an important tool for managing risk in a portfolio. When you’re diversified across different asset classes or industries, it helps to limit your exposure to certain kinds of investment risk. If one investment begins to decline in value, your other investments can help to bolster your portfolio.

A higher allocation to stocks may be optimal if stock prices are rising, but you may want to balance those out with less risky investments, like bonds.

If you’re investing in mutual funds or exchange-traded funds (ETFs), consider what assets each one holds to avoid becoming overweighted in one particular industry or sector.

Go Long in Your Positions

Going long simply means adopting a buy-and-hold approach when investing in a bull market. The end goal is to buy stocks at a low price, then sell them later for a higher price to maximize returns. The key is knowing how to identify the impending end of a bull market so that you can sell before prices drop.

The Takeaway

Bull markets, in which asset prices rise and investors feel optimistic, are a natural part of the market cycle. A bull market begins when a market index rises 20% or more over a two-month period, and it can last months or years. Generally, during a bull market, maintaining a diverse portfolio and a clear idea of your goals can help you manage your investments prudently.

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Is a bull market a good market?

A bull market usually signifies that the market is strong. A market where stock prices are generally increasing can offer an opportunity to buy and hold stocks — if you can purchase them before prices rise too high.

How long can a bull market last?

Bull markets have no set duration; they can last months or even years. When a bull market occurs, it typically sticks around for a longer period of time than bear markets do.

Should you sell stocks in a bull market?

Selling stocks in a bull market could make sense if you’re able to sell them for substantially more than you paid for them. Essentially, it all comes down to timing and what makes sense for your individual goals and tolerance for risk.

Photo credit: iStock/GOCMEN

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