According to the U.S. Securities and Exchange Commission, a bear market occurs when a broad stock market index declines by 20% or more over at least two months. Rallies of various durations can occur before, during, or after even the most severe of bear markets. For example, ahead of the infamous 1929 stock market crash, the U.S. experienced a rally. As the economy crumbled throughout that year, selling pressure in the market reached a fever pitch by mid-October. On Oct. 25, wealthy investors made a series of large purchases in an attempt to stabilize things. This triggered a late-day rally that day, but it couldn’t stop the inevitable from occurring. The stock market tanked on Oct. 28, with a 13% crash on what we now know as Black Monday. The selling continued the next day—with the market falling a further 12%. In another well-chronicled October, this time in 1997, the Dow Jones Industrial Average slid more than 7% on Monday, the 27th. At the time, this was the largest percentage drop in the Dow since 1915. However, the next day, Tuesday, Oct. 28, stocks rebounded sharply, ending the session up nearly 5% on then-record volume.
How a Stock Market Rally Works
Within a bull market or even an otherwise-typical trading day, you often hear about stock market rallies in news headlines or on television. While there isn’t a specific criterion that defines a rally, as there is to officially classify a bear or bull market, it usually presents as a sharp, often-intense increase in stock prices. Rallies aren’t always good for traders and investors. For instance, we often see failed rallies that happen when buyers attempt to stage a rally by purchasing stocks but fail to launch one. A dead cat bounce generally refers to an attempted rally that follows a steep and often sudden drop in stock prices but that ends up losing steam, morphing into further downward momentum in stocks. Dead cat bounces can occur over a matter of minutes, hours, or longer periods of time. This is similar to a “sucker rally,” which tends to develop during a bear market. Things are bad, but a stock, sector, or broad index shows signs of life. They start to increase in price but the optimism ends up being short-lived. The stock or index quickly resumes its decline, leaving buyers with lost value. Thus, the term sucker rally. News events often drive rallies. For example, when New York City announced a partial reopening of movie theaters in February 2021, shares of movie-theater operator AMC rallied on the news into after-hours trading. This upward momentum preceded the stock’s outsized social media-driven and prolonged rally in June before giving way to the mostly volatile trading in the stock that has marked most of the second half of 2021.
What a Stock Market Rally Means for Investors
More than anything, this review of stock market rallies should help reaffirm a longstanding tenet of long-term investing. Don’t try to time the stock market. Be strategic. Put extra cash to work. Just don’t try to time a bottom, top, or the right time to join a rally. Step away from the present day and think about how chaotic events such as the market drop of 1997 can be as they’re happening. More recently, think back to March 2020. The stock market fell apart over four days in that month, with the Dow shedding more than 6,000 points, a loss of roughly 26%. It’s difficult, if not impossible, to navigate such dramatic volatility, even if you’re a skilled trader. If you’re a long-term investor, there’s really no reason to do it. So the best thing you can do if you’ve invested for long-term goals, such as retirement, is stick to whatever longer-duration strategy you’re using. If you’re dollar-cost averaging, which simply refers to buying stock over time at regular intervals, you’ll purchase more shares when prices are down and fewer when prices are up. You operate from a position of strength if you’re able to supplement this strategy with advantageous purchases when the opportunity presents itself. Market rallies often follow market declines. For instance, after hitting a bottom on March 23, 2020, all the major market indexes rallied hard over the next 12 months, with the Dow, Standard & Poor’s 500, and the Nasdaq Composite Index soaring 53%, 58%, and 80%, respectively. After market crashes in October 1987, October 1997, August 1998, April 2000, and October 2008, stocks rallied meaningfully in the days after each plunge. This led researchers at Rowan University in New Jersey to observe: “We document a consistent pattern of investor overreaction in a large cross-sectional sample across five of the most significant stock market crashes of the past three decades. … “Stocks that lose more value in crashes tend to gain more value after the crash with a significant market correction in the post-crash market reversal.” In other words, when the market nears or hits bottom (a bottom you probably won’t be able to precisely predict), don’t overreact. Stand pat. And, if you’re able, add to your positions. History shows this strategy can provide the best chance for you to participate in a stock market rally. Stock market rallies mean different things to different people. It all depends on your goals and context. A day trader who wakes up to a strong market opening might succeed by participating in such a rally, even if it only lasts for an hour. But most long-term investors probably shouldn’t really pay attention.
