What Is A Bull Market?

Summary: What is a bull market and how can you identify one? This page explains what happens in a bull market and how to make stock market profits.

To many people, especially those in the media that need a headline, any period of a few stock market sessions where prices rise is a bull market or at least has the potential to be one. This, however, is not the case.

There is most certainly a difference between a few sessions of gains and a period of genuine economic expansion during the business cycle. It needs to be highlighted that the normal business cycle of a national economy is not a fast moving thing. Therefore, once in a period of growth, it is very likely that the growth will be maintained (at differing rates each month and quarter) for long periods of time.

In simple terms, economic growth leads to greater production of goods and delivery of services. These goods and services require the spending of money in multiple parts of the economy. That spending helps companies to earn more and (hopefully) generate and retain profits.

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When many companies are generating these additional profits, more money will be spent in the economy (pay rises will become more common for example) and the wealth is gradually shared around. As all this money starts to land on corporate balance sheets, investors will like their chances of making a capital gain or dividend income and purchase more stocks and shares.

As more people invest, supply of company assets will tighten and prices will rise. As this happens to many firms, the entire stock market will rise and the Dow Jones is brought to life. These rises bring in more investors and money and so the market continues to rise in price. It becomes self-fulfilling. The upwards market trend brings in ever more investor money!

Typically, as annual rates of return increase, more and more spculative money is brought in. This means that people sitting idly aside start to see everyone they know making a profit investing on the stock exchange. For these people, not really knowing much about the economy or prices, it is pure speculation. They are just trying to "join the ride" hoping for free money. Inevitably, these people are late to the party.

There are undoubtedly many factors that can help to create a bull market, for example fiscal and monetary policy, or the spillover from a neighbouring economy (it often is the case that as one national economy rises and falls, it's nearest trading partners economies expand or contract as well).

The basics

However, a few factors really stand out at a basic level for the promotion of bull markets, and they are the most important - but often overlooked - characteristics. Peace (war usually devastates an economy), genuine democracy and full property rights for the ownership of assets.

In the 'West', we often overlook these factors because we take them for granted, but in many other countries, especially in Africa, the lack of these basics holds national economies back and prevents any real period of sustained economic growth. These can be considered as the basic requirements for capitalism to flourish and without them, economic expansion will be patchy at best.

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It is also worth noting that there are very few actual stock exchanges that we in the 'developed' world may ever consider investing in in Africa. The national economies are often so underdeveloped because of the conditions mentioned above that there is not even a mechanism for a bull market!

The period of expansion will almost always lead from sensible investment to wild speculation. As this happens, valuations become less and less sensible and more risk is assumed by each new investor. The professionals will be selling into a strong market while the unaware average investor is taking much larger risks for much lower potential gains by 'getting in at the top'.

This period of 'top' (also often referred to as 'frothy') may last for months or even years. And during this time, people will be making money and having a great time. This period of wealth may grace the entire economy or perhaps just certain sectors (residential property for example). It may grow into what we now might describe as a bubble. If you hear these words often, it is time to sell!

Of course, nothing lasts forever. A bull market worthy of the name can last for years, but sooner or later, these things end. When that happens, and investors are frightened, the bull may turn into a bear with incredible speed and ferocity.

Bubbles always burst!

Possibly the greatest run up in prices is also linked to the greatest sell off. The great depression that began in 1929 had been preceded by the "raging 20's". Many of the speculators that were making a fortune on the way up had been buying on margin (using borrowed money) which meant that as soon as prices reversed, there was a bloodbath. Prices started to fall, generating margin calls, so people were forced to dump their holdings and on this went in a spiral downwards.

This was also the case in 2001, the "tech bubble" burst and lots of TMT companies saw their prices drop by over 95%, but before, it had been an incredible upwards ride for several years.

To read more about stock market conditions, please follow these links:

Understanding Bull And Bear Market Situations

What Is Economic Growth?

Can You Make Easy Money In The Stock Market?