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What to do when the bulls and bears attack?

One of the more commonly told stories about why Bear markets are called that is that it refers to the London bearskin jobbers or brokers, who often sold a bearskin before the bear was even caught. This short selling became strongly associated with them by the time of the South Sea Bubble in 1721. And so, even today, a period of pessimism in the market which sees wide-spread short selling is called a bear market.

Then there are other etymologies, which no one knows the veracity of. Bull and Bear refer to the way that the animals attack: a bull attacks with its horns from bottom up; a bear attacks with its paw from above, downward. They relate to the speed of the animals: bulls usually charge at very high speed whereas bears normally are lazy and cautious movers. And the list is endless.

So what really is a bull market or a bear market? Is there a definition for it and what�s the right thing a small investor can do in such a market?

Broadly speaking:

A Bear market is a period of pessimism and lack of confidence when volume of trading falls. The indices fall too and the decline is upto 15-20%. Prices are either stagnant or headed downwards and this market usually occurs at the time of a recession or depression. A bear market cannot be confused with a Correction that is much more short-lived, and occurs during bull markets. A notable bear market occurred between 2000 and 2002 in India.

While a bear market is a primary trend, there can be secondary trends in it: temporary change in prices that go against a primary long-term trend, And therefore, during a bear market, you can see Bear market rallies, i.e. short periods ranging from a few weeks to months when prices spurt up 10% to 20%. The Japanese Nikkei Index has seen a number of such rallies.

It is tough to separate a primary trend from a secondary one though. Only time can decide whether such changes in prices are signs of a bull market, a bear market, a bear market rally or a correction.

A Bull market is the exact opposite of a bear market and one in which the markets show confidence. Prices go higher, market indices climb up and volume of share trading peaks. The number of new companies entering the market is also high at such a time. What we have been seeing in India from 2003 to 2007 is a bull market.

The corresponding secondary trend in a bull market is a correction: A correction can be a fantastic time to buy value stocks as they are under-priced and have a strong upside potential.

What to do in Bear markets:

The thing to remember in bear markets is that it is not going to last forever and is a part of the business cycle. Which means you can do nothing but wait for the market to recover again. And so, quite literally - The best thing to do in a bear market is play dead.

Quit looking for explanations on why it happened, most of the time they may be misleading. Think of it instead as a lesson on the importance of risk protection and how quickly shareholder value can be eroded.

If you are a long term investors, you can look to profit from bear markets in two ways. One is if you are looking at Rupee Cost Averaging. Obviously then, this is the time when you get your units at the cheapest, something that will work in your favor. Begin to buy your favorites, whether NTPC, EID Parry, TCS, Infosys, or Hindalco.

Do not aim too high. Dividend yields of 6% p.a. are more than sufficient.

If you think stocks have over-corrected, don�t wait for a total reversal. You can never time the market that accurately. And besides, it could take endlessly long. Stick to your strategy. If you are investing for the long term, stay put. If not, go for money market mutual funds.

What to do in Bull markets

In a bull market, if you have un-invested cash lying around, that is obviously not going to be the most optimal use of your money as it isn�t giving you the highest potential return. In bear markets, your cash will hold value and even earn some interest as stocks head south. So take advantage of rising prices by buying early in the trend and selling shares when they have reached their peak. You will never know for sure when the peak comes, so don�t wait too long.

You can confidently invest in more equity with a higher probability of making a return, given the positive sentiment of the bull market.

The more astute investors will reduce their cost of holding stock by selling if they anticipate corrections, and buying back when the prices fall. In the interval, they would park their funds in money market instruments.

The common sense mantra is to buy low and sell high. So, ideally you should not be buying when stocks are at their peak. But since you fear missing out further gains, buy on days when the averages are down. This way you don't buy at an absolute market peak, even if the difference is not substantial.

Invest your cash in a staggered manner. First buy those stocks that are well off their highs. Then as pullbacks happen, keep picking your favorite stocks.