A bear market rally is a situation that comes about during a time when stock prices are generally trending downward. In the middle of a downward trend, it can occur that stock prices switch directions and rise as much as 15-20% over a relatively short period of time. A bear market rally usually begins quickly, and often without a clear cause. This sudden and significant rise in prices can be deceptive, as it will likely end as quickly as it began, to be followed by a continuation of the downward trend, called a bear market. A price spike such as this in the middle of a bear market is what is called a bear market rally.
The reasons behind a bear market rally can differ, depending on the particular rally, and even on the particular investor. It may be that widespread economic fear has caused a stock market to be oversold compared to where it should be. A bounce in prices would be only natural after a certain amount of panic selling, but will likely be only temporary.
Another reason for which a bear market rally may occur is that after an extended decline in prices, popular sentiment regarding stocks may be that they are undervalued, and essentially "on sale." This type of a rally would be less driven by emotion than the first type, and more driven by a perceived chance to scoop up undervalued stocks for long-term holdings. Financial advisors may contribute to this sentiment, encouraging clients to buy, because prices may not be as low ever again.
Of course, it is impossible to say whether a rally during a bear market is truly a bear market rally until after it is over, when analysts have the benefit of hindsight in studying market conditions. Indeed, if everyone thought that a given rally was a bear market rally, it would end much sooner. Herein lies the dangerous nature of the bear market rally. Investors, eager for economic hard times to be over, may believe that a bear market rally is the real thing -- a genuine recovery -- only to find that before long, prices are back where they were before the rally began, or even lower. This can seriously impair investor confidence in the stock market for a long time, and delay the development of a true economic recovery.
In general, the faster and higher a bear market rally drives prices up, the faster they come back down, and the lower they are, after it's all over. Several famous bear market rallies have demonstrated this trend. The stock market crashes of 1929 and 1987 were both followed by bear market rallies. Also, after the relatively prosperous 1980s, Japan's Nikkei stock index saw many bear market rallies throughout the downward economic trend that took place during those years in Japan.
