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Market Phases: There are four phases to individual stocks and markets movements. Cyclical patterns that develop and can vary in duration. Markets and stocks go up, peak, go down and bottom where accumulation begins. When one cycle completes, the next one begins. It is highly improbable that you will pick the exact bottom or top of a cycle. However understanding them will help you maximize your probability of investment success and trading returns. 

  

Accumulation Phase:

This phase is ideal for the long term or swing investor. After the markets sell off and bottom, then the accumulation phase begins. There are no more sellers, the fear is starting to subside and the healing is beginning. Stocks are consolidating in a sideways pattern establishing a base from which they can begin to rise. This is typically when the so called “SMART MONEY” begins buying. Value funds, smart money managers and experienced traders assume the worst is over and it’s time to start dipping the toe. Valuations are attractive but sentiment is often still quite bearish. There is typically an immense amount of doom and gloom still in the media and the few long term holders that held on through the correction have finally capitulated and thrown it the towel. Usually this is the “RETAIL INVESTOR” that probably got into the party late as the market was topping out and held all the way through the pain of the correction. Just as they decide to quit, others have decided it’s time to pick things up at fire sale prices. This happens with markets and in individual stocks. Sentiment gradually begins to shift from negative to neutral.     

Market up Phase:

Markets have stabilized prices are starting to climb. Early adapters start taking notice and begin to deploy capital, technicians that are seeing stocks or markets putting in higher highs and lower lows recognizing that there is a subtle shift in market sentiment. Generally the media is now talking about the green shoots of a possible recovery but unemployment is still high and continues to rise. Human nature begins to take place and as this phase progresses. Greed begins to take hold, where fear of being stuck in the market is now replaced with being fear of being left out of the market. When this phase nears its end is when the irrational exuberance begins to take hold while logic and reason escape reality. Volumes increase dramatically, stocks climb to mind blowing valuations, “SMART MONEY” and insiders are unloading shares. Unfortunately as they are unloading and the markets level off the “RETAIL INVESTOR” sees this as an opportunity to get in after sitting on the sidelines for the majority of the rally. Prices make a parabolic move higher on massive volume and signal a selling climax or topping out. Euphoria is the feeling of the day and typically the end of the run or popping of the bubble marked by a reversal day.  

Distribution Phase:

This phase of the cycle is when the bears begin to take control and sellers dominate. All the bulls out there have begun changing their tune and are starting to suggest that the markets may be under pressure. Prices are locked in a trading range unable to make new highs; each attempt is met by heavy selling. Support levels eventually break down and now become resistance as the selloffs begin to pick up steam. Emotions run high as fear of loss dominates with brief moments of hope as markets tend to bounce giving the illusion they are getting ready to take off again. Valuations are still extremely high in comparison to historical values. Volatility picks up as markets and stocks make erratic and dramatic moves in either direction. Eventually sentiment changes and can be accompanied by some geopolitical or economic event. Smart money is already out and sitting on the sidelines waiting for the appropriate time to start shorting. Those that fail to get out in this phase typically become the famous “Bag Holders”.  

Market down phase:

This is the most painful and fearful phase of the cycle. The “Bag Holders” that chose to hang on for the ride holding their positions. Their knuckles are white and the whites of their eyes are clear for all to see as the selling intensifies. It’s not until there is a capitulation of selling often resulting in a loss of 50 percent or more for these diehards when they finally relinquish control of their shares and give into the market pressures. Sadly this is what the pros want to happen and for the astute investor, this is the buy signal they have been patiently waiting for. They recognize that a bottom is near and the time to start accumulating is approaching. New investors begin buying so they can take advantage of the next ride up and a whole new cycle is born.

Duration: Cycles happen every day in individual stocks it just depends on what time horizon you are watching. Market cycles can last a few weeks or many years. If you are using a 5 minute chart you could see a cycle play out several times in a single day. If you are a long term investor using daily or weekly charts you could see a cycle last for months or years. Recognizing what phase of the cycle you are in should play a big role in your preparation for trading and help you achieve better results.  

Examples

Perception is everything.

The examples above illustrate how different time frames run through cycles.  

The first chart looks pretty scary however it’s a 5 minute chart and its cycle went from accumulation at 3 dollars, marked up to 3.20, marked down to 3.04 and then began consolidating at 3.07. The total cycle lasted roughly 4 hours.

The second chart is the same stock on a weekly time frame where its cycle began in July 2013 and it’s still active in April 2014. The price range went from accumulation at a $1.06 base, marked up to a 4.25 peak, marked down and currently sits at 3.04 still looking for its new base of accumulation where the cycle will be completed.

Notice how similar both charts appear yet the magnitude of the move is very different. We will be going over timeframes later in the book.