Market Cycles

Introduction to Stocks

Stock market ups and downs cannot be predicted accurately, though they often can be explained in hindsight.

The market goes up when the investors put their money into stocks, and it falls when they take money out. A number of factors influence whether people buy or sell stocks as well as when and why they make decisions.

Moving with the cycles - Pinpointing the bottom of a slow market or the top of a hot one is almost impossible until it has happened. However, investors who buy stocks in companies that do well in growing economies, and buy them at the right time, can profit from their smart decisions and their good luck.

Accumulation Phase - This phase occurs after the market has potentially bottomed. Prices have flattened and for every seller throwing in the towel, someone is there to pick it up at a healthy discount. Overall market sentiment begins to switch from negative to neutral. This is when corporate insiders, smart money managers and experienced traders begin to buy, figuring that the worst is over.

Mark-Up Phase - At this stage, the market has been stable for a while and is beginning to move higher. Experienced nvestors and market professionals who, seeing that the market is putting in higher lows and higher highs, recognize that market direction and sentiment have changed. Media stories begin to discuss the possibility that the worst is over, but unemployment continues to rise, as do reports of layoffs in many sectors. As this phase matures, more investors jump on the bandwagon as fear of being in the market is supplanted by greed and the fear of being left out.

Distribution Phase - In the third phase of the market cycle, sellers begin to dominate. This part of the cycle is identified by a period in which the bullish sentiment of the previous phase turns into a mixed sentiment. Prices can often stay locked in a trading range that can last a few weeks or even months. This phase can come and go quickly. When this phase is over, the market reverses 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.

Mark-Down Phase - The fourth and final phase in the cycle is the most painful for those who still hold positions. Many hang on because their investment has fallen below what they paid for it. It is only when the market has plunged 50% or more that the laggards, many of whom bought during the distribution or early mark-down phase, give up or capitulate. Unfortunately, this is a buy signal for early innovators and a sign that a bottom is imminent.

Timing - A cycle can last anywhere from a few weeks to a number of years, depending on the market in question and the time horizon you are looking at. A day trader using five-minute bars may see four or more complete cycles per day while, for a real estate investor, a cycle may last 18 - 20 years.