Order Flow Trading

Get the Book | Contents | Reviews | Articles | Contact | Login

What are Bull Markets and What are Bear Markets?

Updated: 2017-10-06 14:42:03

You’ve seen these terms explained before, right?

clip_image002 clip_image004

Well if you haven’t, now you have. This is how a “bull market” and a “bear market” are defined in the classic sense. I’m here today to shit all over that and explain the relevance in today’s markets and hopefully leave you with something new to consider.

Usually when we talk about a “bull market” or “being bullish”, we’re simply referring to rising prices; we expect price to rise or are describing a market that is in an upward trend. When using the terms “bear market” or “bearish”, we simply mean we expect prices to go down or are observing a down-trending market.

But in the definitions posted above, there are two pieces of additional information that are critical: time and emotion. Bull markets are characterized by their slow, steady climbs and are due to investor confidence and optimism. Bear markets, on the other hand, are nearly the opposite: they happen quickly and powerfully with fear, panic, or uncertainty to blame. Again, these are more of the classic definitions but that’s exactly why they can actually lead us to some pretty awesome underlying knowledge.

Our first lesson is that of emotion’s role in the speed of price change.

Optimism, confidence, and positivity are perspectives that we see as good things, but they’re terrible at moving price. Their influence is slow and boring. Flip around the emotions—fear, panic, and uncertainty—and now things really get moving. They might not be feelings you’d want to embrace in your personal life, but they’re great for rapid, distinct changes in pricing.

clip_image005[6] clip_image006[6]

So far, this probably isn’t a huge revelation. We pretty much all know from personal experience that negative emotions can be very effective for causing immediate action (like, as a child, when your parents struck fear into your heart by yelling at you to pick up your clothes off the floor). Even when looking specifically in the context of the financial markets, it’s easy to observe how price increases on confidence and optimism are slow compared to when everyone decides to panic and jump ship.

Take a moment and imagine a typical, hard-working grandfather type of character. The kind of man who’s had a steady job for a long time, has a decent savings account, and most of it is in some form of investment. He keeps an eye on the financial markets, but by no means is a full-time trader or investor, just someone who wants to beat inflation and retire at a reasonable age. We will name him Bob.

Bob hears that Company A is performing consistently well. Its balance sheet is attractive, most analysts are giving it a positive review, and it’s a well-known company that’s been around for a while. Do you think Bob gets uncontrollably excited by this? Absolutely not. It’s boring. There’s nothing thrilling or exciting about a steady, consistent performance, even if that performance is great. Will Bob choose to invest in that company’s stock? Yeah, probably, but he’s not rushing to his phone to call his broker or sprinting to the nearest computer to go purchase some shares.

Now picture this instead: Bob hears on a news station that Company B, which he’s invested in, is under criminal investigation and could be shut down. The price is tanking as everyone tries to bail out of the stock as quickly as possible (it could be worthless in a few months!). Do you think Bob will be nonchalant about this? Absolutely not. It’s a legitimate cause for huge concern. There’s no time to spare because as it continues to sell off and drop in price, more investors will become fearful and sell as well: a self-perpetuating collapse. Bob wastes no time and calls his broker immediately telling him to exit any of those shares as fast as possible.


“Yes, sell them ALL or I won’t be able to afford an up-to-date phone”

Now, if you’re asking yourself the question, “Why is the author using companies and stocks for all his examples?” then you’re on to something. That was completely intentional and leads us to our next lesson.

Our second lesson is seeing the importance of initiation versus liquidation

The terms of ‘bull market’ and ‘bear market’ were most notably used when talking about the stock market specifically. While the market structure and underlying mechanisms remain pretty much the same from asset class to asset class, individual equities have some interesting nuances.

Speaking from the perspective of the United States (where the terms originated), most people are generally aware of the stock market. That is, they know what the stock market is (sort of), they know that Dow Jones Industrial Average means something important in the stock market, and that it’s a big part of their retirement savings. Mention the words “foreign exchange” and they think you’re trading your child for a student from a different country.


“Trust me, son. I’m doing this for you.”

The point to take away from this is that retail investing in stocks is much more commonplace than in other assets. On top of that, since these individual equities have much smaller average volumes and liquidity, retail traders and investors as a whole have a greater collective influence on pricing. However, since most of them are longer-term , passive investors, none of them have a margin account with their broker that allows them to short sell. They can buy and then sell to close out, but not the other way around. If they’re opening a new position, they’re going long. If they’re closing out, they’re selling.

So now imagine that we’re looking at hundreds of thousands of Bobs. They’re all looking at Company A and hearing the analyst reviews. They all see that the balance sheet is great and future outlook is awesome. They all recognize Company A as a well-known, established brand and are confident in its longevity. They’ll eventually invest, but none of them are rushing to buy it. More specifically, none of them are rushing to initiate positions.

Because their orders are conservatively scattered over time, the resulting “bull market” reflects that. The climb is slow but steady and lasts for a long time. It may not excite anyone but it’s increasing the price along the way because going long is the only way they enter a position in the first place.

Now think of Company B with hundreds of thousands of Bobs. They've all heard the news. They’re all sweating bricks and trying to rush their orders to their broker as fast as possible. They NEED to get out—not after lunch, not next week some time, but NOW. But remember this is only because they were already in a position and now need to get OUT.

That rush of orders in such a short time causes a heavy, rapid drop in price (and self-perpetuates as mentioned before). The thing is, the only reason that this burst of negative sentiment results in a drop in price is due to the majority of these guys being in long (and so they have to exit by selling) because that’s the only way they play the game.

As investors and analysts observed the results of these phenomena over time, the terms ‘Bull market’ and ‘Bear market’ were coined. We’re left with boring definitions that simply assume up-trending markets are slow and steady while down-trending markets are sharp and rapid—but they missed all the juicy parts and consequently left out some ridiculously helpful observations.

The Underlying Nifty Observations:

1) The boring, more consistent moves happen as people initiate; the thrilling, fast, and major moves happen after those positions get liquidated

The process of initiating positions due to confidence, optimism, and the prospect of participants making a return in the asset being traded is very likely going to be a bit boring. The moves are slower as the participants take time to get in and there’s not a huge sense of urgency to partake. Once these positions have built up, though, if a rush of negative sentiment shows up, liquidation of those positions is sharp and rapid, causing some pretty exciting moves.


As a funny side note here, most schools of thought actually observe this and plan around it to some degree, e.g., Wyckoff used the terms ‘accumulation’ and ‘distribution’ and just about any basic technical analysis guide will talk about how ranges (where we’re likely to see both sides build up positions) lead to breakouts (where the one side finally gives out and bigger, exciting moves happen.

2) Subsequently, having those who are on the other side of your trade get forced out will provide the cleanest pushes for your trade and are a much better driving force than hoping other people join in on your side

Many great, keen traders pick up on this and exploit it to its fullest potential. Tyler, an instructor and pro trader here, LOVES to catch onto moves where one side is nervous and pressured to exit. Jesse Livermore is often quoted as saying his money was made from sitting tight (and waiting for the negative sentiment crashes). Darkstar himself specifically loves to play negative sentiment switches. Hell, even a homeless Eddie Murphy character picks up on it instinctively.

3) All of that makes stop levels of the weak side turn in to great targets

Clusters of stop-loss orders can make for some great definitive targets (which is partly why you hear about them so damn much on this site, especially in the Order Flow News & Data Service). They’re basically specific price points where traders have predetermined they’ll be getting out if the trade doesn’t go their way. If the pressure is on those traders and nervousness sets in, you get to take advantage of a great series of events.

First, people who are on that wrong side of the trade are already nervous and start bailing before their stop is even hit, which drives price further against that side (and more in your direction). As this happens, those still stuck on that side get increasingly nervous as price moves against them and closer to their stop. Finally, the stop level gets taken out, giving a nice final rapid push in price as those orders hit the market, allowing you to exit with a nice gain, but also because now the majority of the wrong-sided traders (who were the driving force behind your trade working) are now out, so there’s no reason to stay in.

Since there’s great knowledge to be had by including these important lessons and observations, here are the modern definitions that will confuse the rest of the trading community but are way more helpful

Bull Market: Not specifically a market with an up-trend, that’s not important. Instead, think of a bull market as an environment where the moves are mainly driven by participants initiating new positions (whether that’s opening a long or actively going short) based on positive, hopeful outlook for that asset’s future. It takes time and is pretty boring, though relatively steady and longer lasting.

Bear Market: Again, not specifically a market with a down-trend, that’s not important. Instead, think of a bear market as an environment that happens after a bull market took place and plenty of players are already holding open positions. As negative emotions set in on one side, they start liquidating their positions and consequently drive sharp, fast, more exciting moves since the negativity is a more urgent motivator.

And that’s pretty much it.

In review:

· Bull market usually refers to an uptrend, but old-school observations told us that they’re slow and steady

· Bear market usually refers to a downtrend, but old-school observations told us that they’re quick and powerful

· These old-school observations were brought on by equities trading, where the masses aren’t typically going short

· As such, any opening of new positions (initiation) was limited to primarily going long

· Of course, this means any closing out of open positions (liquidation) was limited to selling

· Putting all of this together, those old school observations actually tell us that when people are opening new positions on an asset based on positive feelings, it’s a slow climb

· Meanwhile, when people are frantically closing out positions they currently have open based on negative feelings, the moves are more rapid and powerful

· Keeping all of this in mind during a modern marketplace, especially with asset classes like Forex and futures where shorting is common and standard, our understanding of how initiation and liquidation play their roles can help us refine our trading

· You’ll have to deal with one more cheesy joke before this reading is over

In closing, I hope this helps you gain some perspective on the nature of trading and I’m really glad that you were willing to bear with me while I picked apart this topic.

Want better trading results?

Get: Order Flow Trading for Fun and Profit