Hey Trader,
For a while now, I haven’t been shy about expressing the opinion that we are currently in a bear market.
Some traders out there may try to deny it, and wistfully proclaim the bull run will once again resume …
But with the S&P 500 down nearly 13% … and more potential downside still yet to come …
I’m not one of them.
But what exactly does that mean?
And what comes next?
Let’s take a look.
Technically, the definition of a bear market involves a prolonged period where markets shed their value …
Many people consider a drop of 20% or more to be a true “bear market” … but personally, I find it more important to focus on what is actually happening, so I watch for a long, steady drop lower.
How does that compare to what we are seeing now?
First, let’s take a look at the S&P 500 (Ticker: SPX) …
The SPX has been slowly grinding lower for more than two months at this point …
Whereas once traders were in denial that we would break below 4,300 …
We are now flirting with 4,200!
Now take a look at the VIX over the same time period …
The S&P and VIX are typically negatively correlated … so when one goes up, the other goes down, and vice versa.
Here is an interesting fact …
You may be familiar with the volatility zones we talk about here at Option Pit. (If not, here is a brief primer.)
In essence, I have found that volatility, and the VIX, tends to trade within four “zones” … each of which has its own characteristics.
During a bear market, Zone 3, which represents elevated volatility, is much more common than in a bull market.
While we typically view Zone 3 vol as a VIX between 18-23, it can also be as high as 28 or 30…
Which is right about where we are right now.
In a bear market, the VIX can spend months at a time in Zone 3, with some movement into Zone 4. In fact, Zone 3 can often represent a transition zone to Zone 4, which is where we see REAL volatility …
Zone 4 occurs when the VIX is above 30 … as it has been for more than a week.
Zone 4 represents true market panic, and it is not uncommon to see the SPX move 2% or more in a day.
However, while large market moves are not uncommon in a high vol environment …
It is more characteristic of a bear market to look more like a slow grind lower …
Exactly like what we are seeing now.
Take a look at how the S&P 500 fared from 2007-2009, during one of the worst bear markets in history …
Chart courtesy StockCharts
The index lost more than 50% of its value!
However, it is not uncommon to see huge (but short-lived) upward rallies … which we have seen several times already this year.
Take a look at the daily chart of the SPX in October 2008 …
Chart courtesy StockCharts
You can see that there are brief periods where markets move higher … and then once again begin their slow grind lower … and lower …
And as we know … it took about four years for the index to fully recover from its 2008 lows …
But as it did, we entered the longest bull market in history.
On average, a bear market lasts a little under 10 months … but of course it can last for a much shorter or longer period than that.
So how low could we go this time?
This time around, I do not think a trip to 4,000 is out of the question …
And there are some traders out there who feel that 3,000 is closer to “fair value.”
Yes, it will hurt to watch for some …
But if you know how to trade the turbulence and the downturn …
It is very possible to come out of the other side ahead of where you went in, especially once the bull run picks back up again.
We held a special live event on Thursday to discuss the state of the market …
And our predictions about what is next.
What’s your opinion? Do you think this bear market is here to stay … or will it just be a blip on our radar?
Let me know in the comments!
Your Only Option,
Mark Sebastian