Avoiding bear traps

Looking at the FTSE 100‘s movements in the last few days, most commentators believe that we may be seeing a bear trap right now.

Bear markets, a market in which share prices are falling, can present amazing opportunities for long-term investors. Those who buy stocks while the market is down tend to be rewarded in the long run. That said, investing during a bear market is not as straightforward as investing during a bull market.

If you are thinking of buying stocks in the current bear market, there is one thing you should know. It is no secret that in a bear market, the general trend of the stock market is down. What many investors do not realise, however, is that stocks do not fall in a straight line. Every now and then, the stock market will bounce a little (as selling activity temporarily weakens), before resuming its downward trend.

This ‘false reversal’ pattern is called a ‘bear trap’, and it can be dangerous for investors. The reason bear traps are dangerous is that they lure investors back into the market at higher prices, right before the next down-leg of the bear market. Stocks rise a little, and investors think the worst is over. As fear is replaced by greed, they scramble to get back into the market. Then, the market suddenly takes another dive and those who bought at higher prices get crushed.

Analysis of the four previous downturns in 1987, 1998, 2000 – 2003 and 2007 – 2009 show that those bear markets were actually littered with sharp rallies which cruelly turned out to be nothing more than bear traps for the unwary, who were tempted into a ‘buy-on-the-dip’ strategy, only to quickly find themselves in trouble.

The coronavirus situation is far from over, yet the FTSE has rebounded roughly 15%. That kind of bounce seems a little premature and most experts would not be surprised to see another down-leg from here before the market generates a sustained recovery.

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Source: https://www.techlink.co.uk/