Bull vs. Bear Markets: What Historical 'Temperature' Data Says About Selling Early
Filed under: Investment Strategy | Market Outlook
Is It Really “Right” to Sell in Bull Markets and Buy in Bear Markets?
A “market temperature” indicator (and what the historical data actually reveals)
Few indicators offer a definitive, plain-English signal that a market is overheating. While traditional metrics like trading volume or the Fear & Greed Index provide clues, they often lack a clean, intuitive, and consolidated read.
To address this, I developed a proprietary composite score designed around a few core principles:
It should be numerical and intuitive at a glance.
It must utilize robust, established inputs to allow for rigorous historical backtesting.
It should be multidimensional, capturing various facets of market mechanics rather than relying on a single isolated signal.
To achieve this, the index combines four core components, each equally weighted at 25%.
The Four Core Components
1) Momentum Score
Measures price strength relative to its long-term moving average. If the S&P 500 ETF (SPY) trades meaningfully above its long-term trend line while maintaining structural strength, the momentum score increases.
2) Volatility Score
Utilizes the CBOE Volatility Index (VIX) as a proxy for market sentiment and fear. A high VIX indicates elevated market anxiety and volatility, while a low VIX signals a calmer, more complacent market environment.
3) Safe Asset Score
Evaluates the relative strength of equities (SPY) against a traditional safe-haven proxy (Gold).
Stocks stronger than gold indicates robust risk-on appetite is alive.
Gold stronger than stocks signals that defensive asset allocation is taking over.
4) Volume Score
Assesses whether price action is validated by institutional participation. When rising prices are accompanied by expanding volume, it confirms stronger market commitment to the prevailing trend.
Mapping the Scores to "Market Temperature"
Once the four individual scores are aggregated, the composite output is mapped into seven distinct temperature bands:
To maximize its practical utility, I backtested historical periods exhibiting identical "temperatures" to calculate forward returns and win rates.
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In short: how did the market historically behave following these specific readings?
Currently, the S&P 500 sits firmly in the Hot regime. While trading near all-time highs, it has not yet entered a parabolic “blow-off” phase. Following a sustained upward grind, the market temperature is elevated but not yet extreme.
Historical Performance: Navigating 'Cold' Markets
Let’s first analyze historical data for the cooling regimes: Frozen, Frigid, and Cool.
When market conditions chill, market participants typically divide into two distinct psychological camps:
The Defensive Camp: “Fear is dominating; it is time to de-risk and reduce exposure.”
The Contrarian Camp: “Valuations have dropped; it is time to accumulate.”
Which strategy does the data validate? Historically, these cold regimes exhibit a highly nuanced pattern.
Cold Regimes: Average Forward Returns & Win Rates
(Format: Average Return / Win Rate)
| Regime | 5-Day Forward | 20-Day Forward | 60-Day Forward | 120-Day Forward |
| 🧊 Frozen | 0.54% / 60.91% | 2.25% / 66.36% | 5.84% / 77.64% | 9.14% / 80.88% |
| ❄️ Frigid | 0.25% / 60.87% | 1.32% / 66.03% | 3.36% / 74.93% | 5.73% / 77.81% |
| 🌬️ Cool | 0.40% / 62.94% | 1.26% / 69.98% | 3.14% / 72.69% | 5.56% / 75.72% |
Key Takeaways from Cold Regimes
Longer-term expected returns improve significantly, but near-term downside risk remains a critical factor.
In a Frozen regime, the 120-day win rate is robust at 80.88%.
However, as the holding horizon shortens, win rates degrade, indicating a prolonged "pain window" for early buyers.
To illustrate, historical maximum drawdowns (worst-case outcomes) within the Frozen regime highlight the steep tail risks:
5-Day Minimum Return: -17.97%
60-Day Minimum Return: -11.38%
120-Day Minimum Return: -16.54%
Crucial Insight: If the structural macro markdown isn't finished, premature accumulation can expose capital to severe drawdowns before the ultimate bottom forms.
Historical Performance: Navigating 'Hot' Markets
Now let's pivot to the regime that directly mirrors today's environment: the Hot market. During a sustained equity expansion, does upward momentum tend to persist, or are markets structurally primed to roll over?
Hot Regimes: Average Forward Returns & Win Rates
(Format: Average Return / Win Rate)
| Regime | 5-Day Forward | 20-Day Forward | 60-Day Forward | 120-Day Forward |
| ☀️ Hot | 0.10% / 57.34% | 0.36% / 62.02% | 1.84% / 75.96% | 5.44% / 78.13% |
| 🌴 Tropical | 0.16% / 61.93% | 0.73% / 69.59% | 2.60% / 77.88% | 5.64% / 84.56% |
| 🔥 Heatwave | 0.02% / 48.15% | 2.30% / 85.19% | 2.96% / 92.59% | 6.08% / 100.00% |
Key Takeaways from Hot Regimes
An elevated "hot" reading is not an automatic sell signal, though deploying fresh capital becomes statistically trickier.
Short-term (5-day) forward returns underperform relative to cold regimes, reflecting near-term exhaustion.
However, as the holding horizon extends out to 120 days, win rates march steadily higher.
This reveals a core behavioral bias: investors who liquidate core positions prematurely simply because the market "feels overextended" frequently miss out on the highly lucrative tail-end of a powerful cyclical trend.
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The Heatwave regime presents a particularly fascinating data anomaly:
5-Day Win Rate: 48% (akin to a coin toss over the short term)
120-Day Win Rate: 100%
Important Caveat: The historical sample size for this extreme regime is notably small, with only 27 recorded Heatwave observations. A Heatwave can signal a dangerous, speculative blow-off top risk—or it can represent the ultimate continuation phase of a secular bull market.
The quantitative takeaway is straightforward: high market temperatures do not dictate an immediate exit.
For existing positions: Stay aligned with the structural trend.
For fresh capital deployment: Slow the pace of accumulation, execute systematic rebalancing, and establish strict risk-mitigation thresholds ahead of time.
Portfolio Construction: Applying the Temperature Index
The fundamental objective of this index is not market timing or directional prediction; rather, it is optimized for position sizing and risk allocation.
1) Dynamically Calibrating Portfolio Offense vs. Defense
Cold Regimes (Elevated Market Fear): Long-term risk-reward profiles improve, yet near-term drawdowns are frequent.
→ Strategy: Implement dollar-cost averaging via staged buying, establish strict rebalancing thresholds, and lengthen your investment horizon.
Hot Regimes (Strong Risk-On Momentum): Secular trends often persist, but entry multiples are stretched.
→ Strategy: Scale back aggressive new capital allocation, trim overextended winners, rebalance into laggards, and codify stop-loss boundaries or downside protection beforehand.
2) Distinguishing Between 'Averaging Down' and 'Chasing'
Retail participants often succumb to emotional biases, compounding risk in both directions—either buying more out of frustration as an asset declines, or aggressively chasing out of fear of missing out (FOMO) as it rockets upward.
The market temperature score introduces a systematic framework to detach emotion from execution:
Accumulating in cold regimes is mathematically sound, provided you maintain ample liquidity, an extended timeline, and a structured plan.
Pyramiding into hot regimes can be highly effective, provided you are consciously backing a verified, high-conviction trend rather than blindly chasing momentum.
3) Moving Past Binary Frameworks by Overlaying Macro Catalysts
Market participants frequently view market dynamics through a binary lens: "up market vs. down market." In reality, structural moves are far more fluid—cold regimes can compound into deeper selloffs, and hot regimes can stretch well beyond historical norms.
Because this composite index provides an intuitive reading, it pairs exceptionally well with major scheduled calendar risks:
Key macroeconomic data releases (CPI, Non-Farm Payrolls) and central bank policy decisions (FOMC meetings).
Mega-cap corporate earnings calendars.
Overlaying the index against these calendar catalysts allows systemic risk to become quantified and visible.
4) Assessing Top-Down Market Conditions Before Bottom-Up Selection
Even secular compounders and high-quality equities suffer severe multiple compression when the broader market tape turns hostile. Use the temperature index to diagnose the prevailing macro climate first, then evaluate specific single stocks or thematic ETFs within that macro regime.
Conclusion: Rethinking the Bull/Bear Dichotomy
Ultimately, the data shows that the classic adage of selling bull markets and buying bear markets is far from clear-cut.
While cold regimes offer exceptional historical forward returns over a 120-day horizon, the immediate drawdown pain can be severe. This means that buying into a bear market is an excellent long-term strategy, but it mandates a disciplined, staged execution model rather than trying to time a single heroic bottom.
Conversely, hot regimes are rarely outright sell signals. Though your short-term edge degrades, extended holding periods continue to generate strong positive win rates. De-risking too quickly often translates to forfeiting the most powerful leg of a structural trend.
The optimal tactical playbook can be distilled down to this:
In Cold Regimes: Convert systemic fear into structured, staged accumulation.
In Hot Regimes: Convert market greed into systematic risk management.
Implementing this single operational shift can transform your portfolio's stability and elevate your execution to a truly professional standard.
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