Bear Markets Are "Easy"

Being able to identify the current market regime is a very important part to trading. As a systems trader I have a very quantitative approach to things, in fact testing typical Wall Street “known” wisdom against itself is a common hobby of mine. Not to be Señor Snarkypants on Twitter but because there is all sorts of opportunity in finding flaws in areas that gets constantly repeated in financial news, or the aforementioned FinTwit.

The common Wall Street accepted requirement for a Bear Market is down 20%, which did not officially happen but we got within a few ticks of it on a closing basis, and currently down a bit over 14% from the highs.

This is more for a record keeping sense than it is for any trading advantage but I constantly hear people quoting that, we aren’t in a bear market yet because of that mystical 20% number.

There is another saying about bear markets and that Bear Market rally’s are the most violent. That certainly seems to be the case lately as we’ve had some of the biggest rallies EVER.

When you get down to doing the research it turns out that the biggest rallies in the markets do happen in bear markets.

So if the two pieces of information are correct:

1. We aren’t in a bear market until we are down 20% from the highs
2. Bear market rallies are the biggest rallies

Then why did we just have one of the largest single day rallies in US Market History? And coincidentally every other rally of that size happened during, you guessed it, a bear market. Maybe, perhaps this magical 20% number is not all that accurate.

This is where I like to find opportunities to exploit and build systems around. Accordingly we have been in a bear market on US Equity Indexes, on a purely price action basis, since October.

My analysis is nothing secret, I actually use the Van Tharp SQN indicator. He did the hard work with it, I got the idea from him and decided to backtest it myself. Sure enough it does a pretty good job of classifying the market for me so that I know what regime I’m in and I run different systems to exploit the opportunities and characteristics of these regimes.

Specifically in December we moved from a low vol bear market to a high vol bear market, a very strong bear market indeed.

Where as for the most part of the past ten years we’ve been in a pretty low vol bull market, minus 2015 and 2016 which was a bit wild. The beginning half of that period was a nice steady uptick, reward was given to buying higher highs. Then as we went through Brexit and the US Presidential Elections things were very volatile and not much trend. Then the election is done and we go into a huge rip higher where any slight sign of selling was used as a buying opportunity to head higher. Not to mention the short selling of volatility (a low vol environment).

None of those strategies has been very successful since Oct 2018 (the beginning of the bear market).

A strong and volatile bear market has to be traded differently. Either you go to cash, you find a bull market to trade somewhere else, ahem US Treasuries, the Yen, Precious Metals and the Soft Commodities – all are in bull markets, or you work a strategy that is successful in highly volatile strong bear markets.

Also coincidental that we have rallies and bull markets in those above sectors while everything is selling off. It is a pretty common characteristic of a major change underway.