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Bear Markets Explained

In this article we will go deeper into the dynamics determining a sudden shift towards a bear period.

The first thing that has to be taken into consideration when we deal with financial markets, is that human psychology is much more involved in determining the actual trend, than what we could think and expect. Even if nowadays high-frequency and algorithmic trading are getting more and more widespread, when it comes to strategic decisions, the steering wheel is still controlled by the human brain, which in case of fear and panic acts in a different way than the rational one.

When suddenly stress and pressure start to trigger into investor’s minds, it is no more the fore cortex, the rational part of the brain, which takes decisions, but the limbic system is all of a sudden engaged into the hard task to make decisions.

The limbic system is a part of our brain that we have in common with most of the mammals and thus it is the most primitive part of our brain, meaning it has been evolving in order to take sudden decisions that will lead to the struggle for survival. According to many relevant studies on the human brain and its instinctive reactions, there are pre-planned decisions which we are hardly able to control, because it is our instinct telling us what to do.

After this brief explanations of how psychology gets involved in financial markets, we need to deal with some technical details relevant to the history of bear crashes.

A market is defined bearish when stocks decline at least 20% from their peaks. Instead a correction happens when stocks fall around 10%. In the recent history of financial markets, 123 corrections took place, more or less one per year and a bear markets every 3.5 years, usually lasting from 10 months up to 15 months.

At that point a question comes quite naturally: how do you protect yourself from losses? According to the advices given by many Wall Street firms, considering the fundamental analysis can be the key to prevent evil surprises. Two things worth remembering are that we actually can not precisely know how far  will the bottom of a correction go and trying not to seem too trivial, you should invest and bet on what you think will happen in the mid-long term, taking from granted that you can afford to wait for the bounce back.

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