The emergence of trends or patterns during different markets or business environments is referred to as a market cycle or a stock market cycle. It is a period of movement from highs to lows. The movement is from increasing prices, strong performances, and bullish markets to weak performances, falling prices, and bearish markets and then back to bullish markets. The stock price during the movement rises initially then falls down and rises again.
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The reason behind these movements is the outperformance of certain securities and asset classes because business models show conditions of growth. The time frame of a market cycle differs as it depends on an individual’s decision of following the trends. It can last anywhere from weeks to years depending on individual preferences. The top of the cycle is called a peak and the bottom a trough.
Phases of Market Cycles
Accumulation Phase: Accumulation happens when the market touches the bottom and the investors and early adopters start buying thinking the worst is over. This leads to market prices being pushed up. The higher lows signal that the market is in the accumulation stage.
Mark-up Phase: The buyers take over to gain the traction they intended in the first phase. The price is pushed above resistance levels and candles tend to close with strong bullish bodies. The market stabilizes for a while and moves higher in price.
Distribution Phase: The sellers attempt to take their positions back as the prices reach their peak. The chart is flat as similar to the accumulation phase. Lower highs indicate that the market is preparing for the selloff. This also marks the beginning of trend reversal.
Downtrend / Markdown: The bears begin to take over the market and have gained enough power to take the market to a cheaper level. This leads the market price to tumble down leading to a downtrend. The analysis shows that large candles stick out of descending horizontal distribution channels. After this market cycle is completed, the whole thing starts all over again from Phase 1.
Drivers of Market Cycles?
Economics: Leading indicators such as Economic growth, interest rates, the yield curve, credit index, and equity supply are taken into account.
Politics: While investing in different countries we evaluate various factors such as government stability, trade practices, and capital barriers. These factors drive the stock markets
Sentiments: Investor sentiment is an important driver of the stock market as emotions are difficult to assess, hence various factors like margin debt levels and mutual fund flows are taken to indicate investor’s collective sentiments.
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Cycles exist in all the markets, but it is up to the investor as to how he makes profits out of the movements. A smart investor always invests in the accumulation phase as the prices stop falling in this phase. A market cycle is considered to be complete when the S&P is 15% below the highest point or 15% above the lowest point. A smart investor who has knowledge about the different phases of the market can take advantage of this situation. These cycles are the basis of the investment strategy known as Asset Allocation.
Author: Urvi Surti
About the Author:
Urvi is a commerce graduate and has a keen interest in Finance. She has completed her Chartered Wealth Management (CWM) from the American Academy of Financial Management and is currently pursuing a career in Financial Risk Management (FRM).