Today, I wrote to my New Frontier Investor readers about what I think about bears and bear markets in general.
I believe many investors have now fallen into the ‘Bear Trap’. To begin with, what is a ‘bear trap’? I describe it as when the investor becomes bearish on the market yet cannot be sure if the market will continue to fall.
Have you fallen into the bear trap? Let’s use this simple test to find out.
If you are a ‘true’ bear, you are not clouded by uncertainty, you are sure the market will fall further. It can be in gold, the Chinese yuan or the stock market in general. In that case, you short the asset that you are bearish on and you can benefit from the fall.
If you are in a bear trap, it means you are bearish on something without really believing it will fall. Therefore, you will not be confident enough to take a short position. In this case, you are by default believing the market has an equal chance of recovering or moving flat. If that is the case, you are not a true bear, you are just unsure.
Markets move in cycles, and things recover after a while. The total length of bull markets is historically longer than bear markets. So unless you are betting on a total collapse of the system, in which case you should short, you want to simply wait for the bear market to end.
Some may ask, ‘But Ken, how do you know that history will repeat and the market will recover this time like every other time?’ Now that is an intelligent question! The answer is I don’t, nobody does. But I do know that crises only manifest themselves in one way through the stock market — going down. That’s all.
I have been digging into chaos theory (in mathematics) to find the answer. The stock market is like predicting weather patterns. We know normal weather days usually occur but we know storms only happen once in a while. Let’s say normal weather days represent average or bull markets and storm represents market crisis/bear markets. We simply cannot predict when a crisis/storm will hit, but we know they hit at a seemingly random frequency.
I am not going to go into stuff like ‘non-linear dynamic systems’ because it is well beyond our purpose here. However, I strongly recommend you read into chaos theory applied to investment analysis. It will be a very interesting read for you.
Emerging Market Analyst, New Frontier Investor