There is a great medieval fantasy TV series on HBO called Game of Thrones, based on the book series A Song of Ice and Fire. From the outset of the series there is a faction called the Starks which continually warn of the coming perilous winter. The Stark characters ominously utter the phrase “winter is coming.”

Despite being 5 books and 5 seasons into the series, winter has still not showed up. However, as one character wisely points out, “sooner or later the Starks are always right.”

The markets have followed a similar trend these last 7 years. The bears have been predicting the next bear market every year since the start of this bull market. Despite being wrong these last 7 years, like the Starks, sooner or later the bears are always right.

Seven years into the current bull market, yes “winter is coming,” or rather a bear market is coming. Bull markets do not run forever, a bear market is lurking somewhere on the horizon. The question investors are asking is “When?”

To answer the “when” we need to talk about bull markets and specifically how bull markets function, and how bull markets DIE.

The simplest and best description I have is that a bull market acts like a vector moving in space; it runs and runs, until it is knocked off course or runs out of steam.

In the “knocked off course” scenario some event or development comes along unforeseen which shakes the world economy. In this scenario the bull market is cut short. A good estimation for the size of the event causing a bear market would be something capable of cutting 5% from global GDP.

• A great example of this scenario is the 2008 Housing/Financial Crisis. Some may argue that the signs of a housing collapse were everywhere, and that everyone “should” have seen it coming. I won’t try to argue against that, but the housing market alone should not have been enough to trigger a bear market and major global recession.

• The aspect that very few people saw coming (those that did, made a killing) was the systemic implications of a housing decline combined with inconsistent government action pouring gasoline on the fire.

In the “run out of steam” scenario a full bull market cycle is completed as investor sentiment gradually improves until it reaches levels that are unreasonable given the levels of general economic output and corporate earnings/profits/growth prospects. I will use the famous quote from Sir John Templeton to help illustrate this scenario “bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.”

• The 1990s bull market and subsequent bear market that began in 2000 commonly referred to as the “tech bubble” is an excellent illustration of this. During that period US markets had positive annual returns from 1991 to 2000.

• Much like today, investor sentiment remained muted for the majority of the 90s bull market run. It wasn’t until the end that euphoric talk of “a new economy” and “new stock market rules” became the norm, and companies like Pets.com started going public.

• “When beggars & shoeshine boys, barbers& beauticians can tell you how to get rich, it is time to remind yourself that there is no more dangerous illusion than the belief that one can get something for nothing.” Bernard Baruch

The bull market will end when something people do not see coming knocks it off course, or when investor sentiment inflates to a level where the fundamentals of corporations, and the world economy can’t keep up.

Understanding market cycles can be very beneficial for investors.

Recognizing where the market currently is in a cycle can allow an investor to properly overweight/underweight their portfolio to different types of stocks.  Historically it has been shown that doing this even in very simplistic ways, such as adjusting weightings of large cap vs. small cap stocks can create significant long-term outperformance.

While using knowledge of market cycles to hopefully get excess returns is exciting and great, I believe it is a distant 2nd in the “list of reasons to understand market cycles.”

The most important reason for understanding market cycles is it gives an investor the mentality and peace of mind resulting in “Do No Harm.”

A continual theme that I hit on is that the stock market over long-term periods has provided investors with the greatest combination of returns and liquidity compared to other asset classes. However, individual investor returns have historically tended to significantly underperform stocks. The majority of that investor underperformance is attributed to “investor mistakes.”

An understanding of market cycles can help an investor avoid mistakes, and potentially get better than market returns.

Now that we know why understanding market cycles are important, let’s take a gander at some basics.

Bull Market: A general increase in stock market prices over a period of time. (Sidenote: many people are completely unaware that we have been living in the midst of a bull market since 2009, see more on that http://wswartzco.tumblr.com/post/140771393717/bust-out-the-bubbly )

Bear Market: A general decline in stock market prices over a period of time. Officially it is considered a bear market when the decline is of more than 20%. A typical bear market occurs over a 12-18 month period.

Market Correction: A reverse movement, usually negative, of at least 10% in a stock, bond, commodity or index. Corrections are generally temporary price declines interrupting an uptrend. A correction has a shorter duration than a bear market.

Personally the duration, behavior, and perceived cause play a much larger role in differentiating between bear markets and corrections. If the markets tanks 23% and V bottoms back up to previous levels within a ~6 month time frame, I would likely consider it a correction (depending on perceived cause) even though the decline was more than 20%.

Similarly if the markets were to average a decline of 1-2% over several months, and then have a sharp decline which finally bottomed at -18% over a 10 month period start to bottom, I would be very tempted to consider it a mini-bear market despite not hitting the -20% mark.