A bear market rally happens when stock prices go up temporarily during a period when the overall market is doing poorly. Some people call it a sucker's rally, bull trap, or dead cat bounce.
Bear market rallies come with nicknames that highlight the risk for investors who think the market has hit the lowest point when, in reality, the gains are temporary before prices fall again. It's often called a "sucker's rally" or a "bull trap" because optimistic investors who join the rally may face sudden price declines. Another term used is "a dead cat bounce," based on the idea that anything dropping quickly will briefly bounce back when it reaches the bottom.
In 2020, we saw a bear market rally. The S&P 500 Index fell over 20% from Feb. 20 to March 12, officially marking a bear market as it closed at 2,480.64. The following day, the index went up by 9%. However, investors who jumped back in got tricked because the index dropped to 2,237.40 just 10 days later, erasing the gains as the market kept going down.
In February 2020, the Dow Jones Industrial Average reached a peak, but it didn't stay there for long. When the coronavirus pandemic was declared a national emergency, the Dow experienced its three biggest single-day point losses in U.S. history. These drops in March 2020 marked the official end of an 11-year bull market.
Following the big drop on March 9, the Dow went up nearly 5% on March 10. However, by March 11, it closed down at 23,553.22—a 20.3% fall from the highest point on Feb. 12, which was 29,551.42. On March 23, the Dow hit its lowest point of the year, reaching 18,591.93. Fortunately, by the end of 2020, the Dow was making new record highs.
A bear market happens when stock prices drop by 20% or more for at least two months. In a bear market, prices might go up a bit before going down again. This up-and-down movement is called a bear market rally. It's like a temporary gain followed by more losses until the market hits its lowest point. Just like any other market shift, a bear market rally can be a chance to either make money or lose it.
A bear market rally gives day traders an opportunity to make money by betting against stocks. This is a tricky strategy and might not be suitable for beginners.
For long-term investors, especially those regularly adding money to their accounts like in retirement savings, a bear market rally is good news. It means stock prices are expected to stay low for some time. People using a strategy called dollar-cost averaging can benefit from this. They get to buy more shares when prices are cheaper until the market hits its lowest point. This helps bring down the overall average price of the stocks they own over time.
If you're rushing to invest in rising stock market prices because you're afraid of missing out, that's emotional investing, and it usually leads to losses. Investors who have solid plans and diverse investments should steer clear of anything that seems like the beginning of a tricky rally. It's better to stick to their long-term strategies and avoid potential losses.
A bear market rally suggests that the market is going through its natural cycle. It can also mean that some frustrated investors, who have been waiting for a rally, might give up and sell, causing prices to move toward the eventual low point before recovery. In history, bear markets have often bounced back above the levels seen during their rallies, as happened with the Dow in 2020. Despite a significant drop earlier in the year, by December, the Dow was hitting new record highs.
Please note that The Balance doesn't offer tax, investment, or financial services advice. The information is provided without considering specific investor circumstances and may not be suitable for everyone. Investing always involves risk, including the potential loss of the initial investment.