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This may be an extremely naive question, but it is often discussed on the news, here and in person (at least in financial circles) that it is easy to make money in a bull market, and harder to make money in a bear market. That is, in a market where stocks are expected to rise, throw a dart and there's a decent chance it'll land on something good. In a market where stocks are expected to fall, it takes some careful searching to find the winners. BUT WHAT ABOUT SHORT SELLING?!

Why does it need to be harder to make money when the market is bearish? It seems to me that in a bull market, one should bet on the winners going long, and in a losing market, bet on the losers going short. Most big brokers make it about as easy to short as long, so why the discrepancy?

  • 1
    Note that bull or bear market is a description of what the market was doing last time you looked at it and a guess at what it might do in the future. That guess may be wrong, and/or any particular stock or sector may go in the other direction... and the mood of the market can reverse in a flash, sometimes more than once. Beware of letting the fact that people call it a bull or bear blind you to what's actually happening. – keshlam Sep 24 '15 at 17:04
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Who are the losers going to be? If you can tell me for certain which firms will do worst in a bear market and can time it so that this information is not already priced into the market then you can make money. If not don't try.

In a bull market stocks tend to act "normally" with established patterns such as correlations acting as expected and stocks more or less pricing to their fundamentals. In a bear market fear tends to overrule all of those things. You get large drops on relatively minor bad news and modest rallies on even the best news which results in stocks being undervalued against their fundamentals. In the crash itself it is quite easy to make money shorting. In an environment where stocks are undervalued, such as a bear market, you run the risk that your short, no matter how sure you are that the stock will fall, is seen as being undervalued and will rise. In fact your selling of a "losing" stock might cause it to hit levels where value investors already have limits set. This could bring a LOT of buyers into the market.

Due to the fact that correlations break down creating portfolios with the correct risk level, which is what funds are required to do not only by their contracts but also by law to an extent, is extremely difficult. Risk management (keeping all kinds to within certain bounds) is one of the most difficult parts of a manager's job and is even difficult in abnormal market conditions.

In the long run (definitions may vary) stock prices in general go up (for those companies who aren't bankrupted at least) so shorting in a bear market is not a long term strategy either and will not produce long term returns on capital.

In addition to this risk you run the risk that your counterparty (such as Lehman brothers?) will file for bankruptcy and you won't be able to cover the position before the lender wants you to repay their stock to them landing you in even more problems.

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To short:

  1. need margin account. Not needed when going long
  2. need to borrow stock from some other investor. Not needed,etc.
  3. need enough capital to cover short. Not needed, etc.
  4. need to have stock to buy, i.e. find stock for sale. Liquidity an issue.
  5. In addition to the above, many brokers require higher minimum account sizes for the obviously higher risk of shorting. Not needed, etc.

Of course, you may always buy some index correlated ETF that eliminates the above. They use stock futures on the index, and you simply buy the "shorting ETF" in your non-margin account. However, they are surprisingly high cost, and despite the intended correlation, have significant drag. It's a much safer way to short the market (you have great choice in which market ETF) and eliminates the single stock risk.

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The main difference between a bull market and a bear market is due the "the leverage effect".

http://www.princeton.edu/~yacine/leverage.pdf

The leverage effect refers to the observed tendency of an asset’s volatility to be negatively correlated with the asset’s returns. Typically, rising asset prices are accompanied by declining volatility, and vice versa. The term “leverage” refers to one possible economic interpretation of this phenomenon, developed in Black (1976) and Christie (1982): as asset prices decline, companies become mechanically more leveraged since the relative value of their debt rises relative to that of their equity. As a result, it is natural to expect that their stock becomes riskier, hence more volatile.

More volatile assets in a bear market are not such good investments as less volatile assets in a bull market.

  • I forgot to add this point from corporate valuation, thanks! – MD-Tech Sep 24 '15 at 14:20
0

If you know what you are doing, bear markets offer fantastic trading opportunities. I'm a futures and futures options trader, and am equally comfortable trading long or short, although I have a slight preference for the short side, in that moves are typically much quicker to the down side.

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