What goes up, comes down. And what goes down comes up again.
Anyone who is even slightly involved in the stock markets is aware of this simple yet profound truth. Yet, there are millions of investors who make the mistake of entering the market just as it is peaking and find the exit route non-existent.
To keep away from the folly of investing in the market at the in appropriate time, it is vital to understand the cyclic nature of the market.
A good grasp of technical analysis fundamentals and an understanding of how the market works is also very useful in predicting market movements.
The Four Phases of Cycles
Like in real life, all financial markets move in cycles. No matter what market you are referring to, all have similar characteristics and go through the same phases.
Phase 1: Accumulation
This is the time when the market is languishing at the bottom. It is preceded by a crash, but the worst is over. There do not seem to be more bad news in the offing. Entrepreneurs and smart investors realize this early and have already started buying in small lots. The market sentiment though is still bearish. However, prices tend to stay flat, as for every seller, there is some interested buyer.
Phase 2: Marking up
The market is now almost stable. The media has stopped painting gloomy pictures. Buying is slowly gathering momentum. It is at this point that most technical analysts advise a cautious ‘buy’ signal. This is because the market is giving higher highs as well as higher lows. As this phase begins to end, the late majority tries to jump on the bandwagon and the market volumes begin to rise. Valuations gradually climb, and rationale begins to take a back seat. Every price decline provides opportunistic investors to buy, and jump in the rally. Prices see parabolic move. The sentiment is very bullish.
Phase 3: Distribution
This is the phase when the bullish sentiment slowly turns uncertain. Prices no longer move parabolic; they move in a band. People become unsure of the direction the market is heading, and the market gradually reverses its upward direction. Classic patterns like double and triple tops, as well as head and shoulders top patterns, are examples of movements that occur during the distribution phase. Wise investors have already moved out, or almost completed booking their profits.
Phase 4: Sell off
This is time when panic and bad news completely grip the market. Prices come down dramatically. If the accumulation phase takes some time, the sell off phase comes quickly. Laggard investors who have been holding on to their long positions lose heavily, suffering more than 50% loss. The volumes too become erratic, and the newspapers begin publishing nothing but gloomy news. Bringing the cycle a full circle…
It is thus seen that smart investors who recognize the different parts of a market cycle are more able to take advantage of them to profit.