There are 2 ways to define a “bull market” vs a “bear market”.
- A state of mind (investors’ psychology)
- A quantitative method.
In terms of investor psychology, a bull market is “a prolonged period of rising market prices”. This means that the market’s medium-long term trend is going higher even though there may be corrections along the way. Bull markets are characterized by:
- General investor optimism (expectations that the market will rise in the medium-long term).
- Positive or improving fundamentals. Each market’s “fundamentals” are different. For example, the stock market’s fundamentals are the economy and corporate earnings.
The key phrase here is that prices are trending higher in a bull market. But how do you define this concisely? How much do prices need to rise for it to be a bull market? How long do prices need to go up for?
That’s where the quantitative method comes in. The generally accepted definition of a “bull market” is an increase of 20% or more for the stock market. Conversely, the generally accepted definition of a “bear market” is a decrease of 20% or more stocks.
*Other markets define this differently. For a highly volatile market like silver, a 20% decline is merely a “correction” and not a bear market.
Problem with the standard definition of a bull market
I don’t like it when the conventional wisdom defines a “bull market” as a 20% increase in prices.
Why 20%? Why not 25%? Why not 30%? Why not 18%?
20% was an arbitrary figure picked out of Stock Traders Almanac more than half a century ago. It became widely accepted simply because it was one of the first definitions.
What we’ve noticed is that 20% is not the accurate way to define a bull market. The stock market can sometimes rally >20% in a bear market, and still there will not be a “general sense of investor optimism” that is characteristic of true bull markets.
Time is also a very important factor in defining a “bull market”. A 30% uptrend that lasts for 2 months is very different from a 30% uptrend that lasts for 2 years.
Here’s how we define this term:
Anything that’s not a bear market is a bull market
The stock market is different from forex and commodities: it has a natural long term bullish bias.
This means that:
- As long as it’s not a bear market….
- Given enough time….
- The stock market will go up.
This means that if the market consolidates for a long time and the conditions for a bear market aren’t present, the stock market will break out on the upside.
Hence the U.S. stock market has had several bull markets in history.
- 2009 – present
All of these bull markets saw the S&P 500 increase by multiples. They all lasted for years. There was a bear market between each of these bull markets. Each of these bear markets saw the S&P 500 fall at least 40% and fall for at least 1 year.
There were many 15%, 20%, and even 25% declines during these bull markets. These are called “significant corrections” according to our Medium-Long Term Model.
How should you invest or trade a bull market
A lot of professional traders like to trade in and out of a bull market. But here’s the reality.
If their trading in and out of the market can’t even beat a simple buy and hold strategy in a bull market, then they are no better than non-professionals. They shouldn’t be trading the bull market. They should be investing in it.
Here’s how some traders trade a bull market.
They want to get in and out of each single wave in the bull market. Unfortunately for them, the stock market has a very strong bullish bias in a bull market, which means that they end up missing out on a big chunk of the bull market.
That is why it’s better to focus on long term investing rather than short term trading in an equities bull.
The optimal strategy for a bull market is buy, hold, and avoid the “significant corrections”. Trying to avoid each and every “small correction” isn’t worth it. Let’s assume that you think an 8% “small correction” is on the way. You sell your position. What happens if the market first goes up another 11% before it makes an 8% “small correction”? You will buy back your position at a higher price!
I’ve seen countless stock traders get excited by “I made 20% this year!” Yea, except the S&P 500 went up 30%. Their trading in and out of the market led them to do worse then someone who did nothing but buy and hold.
Constantly trading in and out of the bull market isn’t a good idea because this strategy tends to underperform a pure buy and hold strategy. Short term trading usually makes you miss out on big chunks of the rally.
Here are several other ways to beat buy and hold in a bull market.
Buy the high beta stocks
“Beta” = the individual stock’s relative performance to the broad index.
- A beta of >1 means that if the stock market moves 1%, the individual stock will move >1%.
- A beta of <1 means that if the stock market moves 1%, the individual stocks will move <1%.
High beta stocks rally more than the broad stock index in a bull market. This also means that a high beta stock will fall more than the index when the broad market goes down. That’s why it’s important to avoid “significant corrections” and bear markets, which is what the Medium-Long Term Model tries to predict.
High beta doesn’t just apply to bull markets in stocks. The concept of high beta also applies to commodities. Certain commodities go up more than others in a commodities bull market. For example, silver is always more volatile in gold. That’s why it’s better to invest in silver than gold during a commodities and precious metals bull market.
Buy leveraged ETFs
This is the strategy that I use in my Medium-Long Term portfolio. I either buy 2x leveraged ETFs (SSO) or 3x leveraged ETFs (UPRO).
These leveraged ETFs are indexed to an underlying market such as the S&P 500. When the S&P goes up by 1% in a day, the 2x ETF will go up by 2% and the 3x ETF will go up by 3%.
But here’s the beauty about leveraged ETFs in a bull market:
If the underlying market rises e.g. 20% in a year, a 2x ETF won’t rise 40%. It will rise more than 40%.
This is called “ETF compounding”. It’s a mathematical phenomenon that’s the opposite of ETF erosion. I explain it in detail here.
Basically, leveraged ETF’s match the underlying market on a day-to-day basis but not a week-to-week or month-to-month basis. A leveraged ETF will “compound on itself”.
Don’t buy futures
Some traders like to buy futures contracts for leverage. I don’t think this is a good idea. The good thing about a leveraged ETF is that you will never face a marginal call as long as you use your portfolio’s cash to buy that ETF. Hence, you can hold your position until you’re right. If you lose money, all you have to do is hold it for a few months and the market will come back up (if your bull market case is still valid).
The same is not true of futures. You cannot hold until you’re right with futures. Futures contracts force you to set aside margin in the event of losses. If those short term losses exceed the amount of margin (cash) you set aside, your broker will clear you out of that trade automatically. You will automatically be forced to take that loss.
This is a problem. Futures sometimes force you to cut your position at the bottom of the market (i.e. the worst time possible). Here’s an example.
- You bought futures contracts at $100.
- You set aside enough margin to withstand a decline to $90.
- The market falls to $89. You face a margin call and your broker clears out your position. You lost money.
- The market then promptly soars to $140.
As you can see, a short term dip in the market turned a big potential profit into a loss.
Buy the sectors with the strongest fundamentals
The stock market has many sectors:
- Consumer Staples
- Consumer Discretionary
- Real Estate
These sectors don’t all perform the same in a bull market. Some lead and others lag. The sectors that outperform usually also have the strong fundamentals – i.e. their earnings grow the fastest, regardless of valuations.
The essence behind William O’Neill’s CAN SLIM strategy for picking stocks is that you always want to buy the sectors/individual stocks with the strongest fundamentals. These tend to outperform during a bull market. Sectors with weak fundamentals tend to underperform.
For example, the tech sector experienced above average earnings growth in 2017 (a bull market year). Hence, tech outperformed the S&P 500. Investors who bought a tech ETF like XLK would have outperformed investors who bought and held a simple S&P 500 ETF like SPY.
Do not short in a bull market
Some traders like to play the bull market from both the long and short sides. Don’t. This is extremely dangerous, and over the long run almost always ends up with losses on the short side.
It is insanely hard to catch the short term tops in a bull market. The market’s bullish bias means that the market will probably rally higher than you think before a correction or pullback begins.
This is also why you shouldn’t short a bubble or try to short the top of a bull market.