In Using Investor Sentiment as a Contrary Indicator it was noted that bearish sentiment reached a record high of 70.3% on March 5, 2009. That is, investor fear hit its highest point at the lowest level of the bear market. It is always the darkest before the dawn. But at that moment, people extrapolate the darkness into the future as if they'll never seen the dawn again. To understand how major bear market low points develop, it's important to understand investor sentiment / behavior and which investors are those who are panicking at lower prices. 

The Supply and Demand of Market Prices: Selling Pressure Overwhelms Buying Demand to Push Prices Lower and Lower

As prices begin to fall in a bear market, selling continues to push prices lower and lower until the panic sellers have sold. Market prices become serially correlated. That is, contagion affects price trends. Prices drift lower simply because the previous prices are drifting lower. Declining price trends cause further declining price trends. When the S&P 500 stock index declines -10% in 3 days, investors and traders take note and make their present decisions based on the recent past. As prices fall, they respond to falling prices. Initially, falling prices may attract new buying demand. But as prices fall lower and lower, selling pressure increases. Eventually, selling pressure drives prices low enough that causes panic selling. It is panic selling that causes a waterfall decline that eventually ends with prices. Panic sellers have stayed in too long, so they want out at any price.

Who are the Panic Sellers? Passive, Buy and Hold, Asset Allocators Who Rely on Long Term Market Averages to Repeat in the Future are the Investors Who Panic

Panic sellers have stayed in too long, so they want out at any price. The panic sellers are the "long term" investors who had relied on a passive buy and hold asset allocation model for protection, but they learn that in financial crisis all markets fall together- they become serially correlated to the downside as contagion sets in. Passive investors often have a set asset allocation between stocks, bonds, cash, and they'll only rebalance at some arbitrary point in time rather than selling expensive assets and buying cheap ones. These "Strategic Asset Allocators" typically have some prediction about the long term expected return of stocks, bonds, real estate, and cash. Since they believe "risk" is volatility, they also predict volatility to be used as their risk measure. Their predictions are based on the past. They assume long term returns and variation will continue into the future. In bear markets, these historical averages don't hold. Instead, the downside moves are much larger than their assumptions expected and the volatility is much greater. When the markets stray farther than they believed, these investors realize their losses are much larger than expected and they sell out of panic. In some cases their panic selling may be because their losses have exceeded their tolerance for risk. But in many cases, they have lost more than they can afford to lose: their losses have exceeded their capacity for loss. Since strategic asset allocators who passively hold indexes or funds and their only tactic is to rebalance, they have no predetermined exit point on the downside that tactically determines their risk. Therefore, a passive / strategic asset allocation strategy that provides no exit point in which to intentionally cut losses has potentially unlimited risk. Prior to losses become unlimited, however, even these investors reach their "uncle point" and sell at the point that their tolerance or capacity for loss has been reached or exceeded. Unfortunately, most of the time they are selling at the lowest lows. 

Eventually, the active risk managers like myself who had already exited in the early stage of the bear market before prices became a waterfall decline are ready to buy at lower prices. Buying demand from those who raised cash at higher prices eventually overwhelms the panic selling pressure from those who overstayed their positions into the waterfall decline. When buying demand from those with cash overwhelms selling pressure from panic sellers who want out at any price, prices then start to reverse and rise again as the sellers who want to sell have sold.