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How Bear Market Rallies Can Fool You

By Jason Markum

Investing in the Stock Market can be very exciting, but at the same time it can be terrifying to make the wrong bet on a stock or the wrong bet in your underlying investment strategy. All it takes is one or two mis-steps to wipe out your entire investment portfolio. Overnight you can watch years and years of careful savings and investment evaporate like it never existed!

One huge trap that many investors fall into, both amateur investors as well as professional investors on Wall Street, is to fall for a Bear Market Rally. They are incredibly easy to get sucked into and are probably some function of hope and human nature that can be devastating if you don’t watch out!

First of all, what exactly is a Bear Market Rally? Well, generally speaking, a Bear market rally is a rally that occurs during a bear market. Stocks fall across the board for a long period of time during a bear market. After days, weeks, even months of watching stocks fall, suddenly you notice that they are starting to rise again!

You wait a few days, maybe even a week or two, and see that the rally has continued! Maybe the Bear market is truly over! That’s when you fall into the trap and start investing again! Inevitably the same thing happens in every Bear market…they turn back downwards. No, the bear market was NOT over…it was just taking a little breather on its way back down.

What causes a bear market rally? Usually it has to do with short sellers, who have been selling short for some time and making a killing. Eventually the short sellers need to cover their positions and buy back in. If enough short-sellers buy back in any one time, this excess demand can make the stock prices increase. A short increase in prices can fuel speculation from people like you who think the bear market may be over and buyback in.

Of course eventually all the short-sellers will have covered their positions and demand will decrease back to its present downward level and the bear market will continue, often wiping out the increases that you just saw.

Bear market rallies generally tend to last about five or six weeks and not much longer than that. In fact, once a bear market rally ends, it usually ends abruptly and the stock prices across the board usually drop dramatically right away.

I know that it is incredibly hard to watch the stock market increase day after day and week after week after an extended bear market has shown nothing but plunging prices for months on end. It’s just human nature to hope for the best, and hope that the bear market is actually over.

That’s the trap that most investors fall into. You have got to be able to look past that emotional side of it and instead focused solely on market fundamentals. If the fundamentals of the market have not improved, then the bear market is not going to be over even if prices are increasing across the board.

So keep an eye on fundamentals, and as always in the stock market, try to keep your emotions out of it and you should be just fine in the long run.

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