How to Spot a Bear Market Rally

Bear market rallies can lead to big opportunities but also poor investing decisions if misunderstood. With stock indices falling and due a bounce, it's a good time to take a look at this phenomenon.

---------------

What is a bear market rally?

A bear market rally is sometimes called a "sucker’s rally" or a dead cat bounce. Just like rising markets experience corrections that don’t go all the way back down, bear markets experience rallies that don't fully recover prior losses.

The move higher can lure traders into thinking the worst is over and buying back in before the market moves even lower. They also happen for similar reasons that corrections happen; sellers get exhausted, and the market needs to rebalance a bit.

The hard part is that there is no sure-fire way to know if the market is in recovery or just a bear market rally until it's all over. And, by then it's too late. But, if we understand how a bear market rally works, we'll have a better chance of avoiding its siren's call.

What happens during a

A bear market is defined as a decline of more than 20% in the stock market from a recent peak. Optimistic traders either leave the market as they are constantly proven wrong, or they are forced out by margin calls. Then, opportunistic traders figure that at least a localized bottom has been reached, and start buying. This will push the market up for a while. If it fails to gain enough momentum, then the market will falter, and the traders taking profits, perhaps exacerbated by new short-sellers that will push the market over again.

How to spot one

Firstly, there has to be a downtrend in prices for a bear market rally to happen. A bear market rally can happen over a few days, or up to a few months. Typically, though, a bear market rally is defined as a period when the stock market goes up for at least two weeks in a row. The price action will be fast-moving and volatile rather than calm and undulating because of the sudden change in sentiment.

Where’s the SP500 at?

The SP500 fell to a low of 3640 last week. This was a decrease of more than 20% from its high of 4820, officially entering a bear market. The index has recovered some 3% this week, but it remains well below the 20% threshold, which is near 3850 price-wise.

In the event price breaks above 3850 a bear market rally could be taking shape. The first resistance is a gap between 3875 and 3910. Above 3910, we can expect resistance at the 4000 round level, and then the 4170.

Inversely, if we lose the weekly low at 3640, 3500 and 3200 are the 50% and 61.80% Fibonacci retracement levels of the 2180-4820 rally and could offer support.

Source: Spreadex trading platform

Conclusion

Bear market rallies present big short term trading opportunities but are risky to trade. The rally is usually fast-moving, which can mean jumping into trades late after the market has turned but with no sure-fire way of knowing when to get out. The alternative strategy is to try to short-sell the top of a bear market rally while running the risk that it is a real recovery and that the price keeps moving higher.