Bull markets, bear markets, corrections and crashes

In simple terms

Markets move in long swings as well as daily wiggles. The language for those swings borrows two animals.

• A bull market is a long period when prices are generally rising and investors are optimistic. It is usually associated with a growing economy and rising company profits.
• A bear market is a long period when prices are generally falling and investors are pessimistic. It can be triggered by a weak economy, a recession, a financial crisis, geopolitical tension or other shocks.

Two more words describe falls of different sizes and speeds.

• A correction is a fall large enough to notice but not as deep as a bear market. It often happens within a longer bull market.
• A crash is a very steep fall over a short period, often days or weeks, usually driven by panic.

Measuring a fall

The size of a fall is measured from the most recent peak. This fall from a peak is called a drawdown.

If an index peaks at 26,000 and drops to 21,840, the drawdown is (26,000 − 21,840) ÷ 26,000 = 16%. By the usual convention that is a correction, not yet a bear market.

The maths of recovery

Here is the single most important number in this lesson. After a loss, you need a bigger percentage gain to get back to where you started, because the gain is calculated on a smaller amount.

What history shows, and what it does not

Indian markets, like markets everywhere, have gone through repeated booms and slumps. The global financial crisis of 2008 and the sudden fall at the start of the COVID-19 pandemic in early 2020 both produced steep drops in Indian share indices, and in both cases broad indices later recovered and went on to new highs.

Two cautions belong next to that fact. First, recovery of a broad index says nothing about any single company: many individual shares that fell in those periods never regained their old prices. Second, the past pattern of recoveries is not a promise. It reflects the growth of the economy and of company profits over those particular years, and the future may be different.

Why it matters

Expecting falls is part of investing in shares. People who understand that corrections are common, and that bear markets happen every so often, are less likely to panic and sell at the bottom, which is how temporary losses become permanent ones.

The recovery maths also explains why risk control matters more than chasing the biggest gains. Losing 50% requires doubling your money just to get back to the start. Avoiding ruinous losses, through diversification and by never investing borrowed money you cannot afford to lose, is covered in the next lesson.

Limitations

The labels in this lesson describe the past. They do not tell you what will happen next. A 10% fall might become a 30% fall or might reverse tomorrow, and neither news commentators nor experts can tell you reliably which. The percentage thresholds are conventions, so different sources may label the same period differently.

Measuring drawdowns from index levels also ignores dividends, which soften falls slightly for long-term holders.

Common mistakes

• Thinking a loss and an equal gain cancel out. A 30% fall followed by a 30% rise leaves you 9% down.
• Believing someone can call the top or bottom. Many people confidently predict turning points; their record, taken as a whole, is poor.
• Assuming every share recovers when the index does. Indices recover partly because weak companies are replaced and strong ones grow. Your shares may not be among them.
• Treating a bull market as proof of skill. When almost everything rises, it is easy to mistake a rising tide for good decisions.

Try it yourself

1. A portfolio falls from ₹2,50,000 to ₹1,75,000. What is the drawdown?
2. What percentage gain does it need to return to ₹2,50,000?
3. If it gains 20% a year after the fall, roughly how many years does recovery take?

Answers: 30%; ₹75,000 ÷ ₹1,75,000 = 42.9%; after one year ₹2,10,000, after two years ₹2,52,000, so about two years, even at a strong 20% a year.