Capital Market Hub
When it comes to investing in the stock market, it’s important to remember that it’s not always sunshine and rainbows. Sometimes, the market can be a real rollercoaster ride. But don’t worry, we’ve got your back. We’ll teach you how to navigate those ups and downs, also popularly known as bull and bear markets.
Stock market cycles are like the “mood swings” of the market. One moment it’s feeling great, and everything is on the rise (bullish phase), while the next moment it’s feeling down and everything is in a downturn (bearish phase). Understanding these cycles is like understanding your significant other’s mood swings, it can help you make informed decisions and potentially maximize your returns.
Let’s explore this stock market cycle in great detail in this post. We’ll discuss what they are, how they are formed and what you should know in order to recognize them. Whether you are a novice or a seasoned trader, being aware of stock market cycles can enable you to optimize your decisions and profits.
What Is the Market Cycle?
Market cycle is a very broad yet personalized term and it depends upon the user using it for example, if a stock trader is talking about it he/she is referring to the stock market cycle and if the crypto trader is talking about it it means the crypto market cycle and so on. To put it in a defined way it is the natural peak and fall of market prices, which is marked by periods of rise and decline that markets exhibit over time. these are based on the fundamental idea that the market moves in a predictable manner, going through phases of growth and decline.
Market cycles though have a diverse variety of durations and are not always predictable exactly when it comes to the market changing its cycle, but they often tend to repeat. Being aware of them and developing a proper strategy to spot them can help investors time the market cycles and make smart investing decisions.
How Are Market Cycle Formed?
It is a complicated process driven by a variety of elements such as economic conditions, investor attitude, and government policy. The rise and fall in economic growth is a key driver of market cycles.
When the economy is expanding, investors become more hopeful and willing to take on more risk, which might result in a bull market. When the economy is sinking or growing slowly, investors become more cautious and risk-averse, resulting in a bear market.
Another important factor is investor sentiment. When investors are feeling confident and optimistic, they tend to be more willing to invest in stocks, which can drive prices higher. Conversely, when investors are feeling pessimistic and fearful, they tend to pull their money out of the stock market, which can drive prices lower.
Government policies also play a role in shaping market cycles. For example, when interest rates are low, it can make it easier for companies to borrow money, which can lead to increased investment and economic growth, whereas this is the opposite in case interest rates are high.
Among many other aspects, it’s important to note that market cycles can also be influenced by external factors such as natural disasters, political turmoil, and pandemics. These events can lead to a sudden change in investor sentiment and have a significant impact on the stock market. While the stock market is known for its volatility, the market cycles are the predictable pattern of its volatility. With the help of market cycle analysis, you can better anticipate market conditions and make more proactive decisions.
What Are the 4 Phases Of Market Cycle?
The different phases of the market cycle are accumulation, markup, distribution & markdown. Let’s drill down on each of these to gain more information about these phases like what they are, how they occur, when they occur and how you can try to time them.
What Is the Accumulation Phase In the Market Cycle?
This is the initial phase in the stock market cycle, characterized by low market activity and low prices. Investors who are aware of the market cycle begin to accumulate stocks during this phase, with the belief that prices will rise and reward them handsomely in the future.
During this phase, you should always take a long-term view and buy stocks that you believe are undervalued compared to their peers and the industry they belong to. Looking for companies that have strong fundamentals, a solid management team, and a clear growth strategy along with the valuation is very essential. This phase is also known as the “value” phase, as investors look for market value.
It’s important to note that the accumulation phase can be challenging to identify and requires a long-term perspective. Its length may vary from a few days to years and also depends upon the time frame you are looking at. Investors who are able to identify this phase and take advantage of the opportunities are more likely to achieve long-term success in the stock market.
How Do You Identify the Accumulation Phase?
As said earlier it is challenging to identify this stage but it is not impossible. You can time this phase with many techniques one of which will be given here, you can create many variations and always keep in mind that the past for trend analysis and economics particularly macro-economic analysis can give the signal when it comes to identifying these types of stages.
Among many factors some of the signals you can read in order to time this stage are provided below:
- Technical Analysis: You can take the help of technical indicators such as moving averages, relative strength index (RSI), and other chart patterns, you have to first identify whether the market is in a bullish or bearish phase before looking for signs of accumulation. A simple example is, a bullish crossover(a shorter time moving average is in the process to go above longer) of the 50-day(shorter time frame) and 200-day moving averages(longer time frame) can be a sign that the accumulation phase is starting.
- Market Sentiment: This is very essential when it comes to market analysis. By keeping an eye on overall market sentiments, which can be done with the help of indicators such as the put-call ratio and the volatility index (VIX), you can get a sense of whether investors are becoming more bullish or bearish. For example, a low VIX indicates that investors are becoming less fearful and more bullish, which can be taken as another sign that the accumulation phase is starting.
- Valuation Metrics: Another thing to consider is looking at valuation metrics. Using simple metrics such as the price-to-earnings ratio (P/E) and the price-to-book ratio (P/B), you can get a picture of whether the stock you are considering is undervalued or overvalued. For example, a low P/E ratio in comparison with its peers and the industry it belongs to can indicate that a stock is undervalued, and if some unusual price action is happening at that time, it can suggest that the accumulation phase is starting.
- Economic Indicators: Macroeconomic indicators such as GDP, unemployment rate, consumer confidence, and inflation, though these are lagging indicators, can help you a lot in your quest to find out the phases of the market. You can get a sense of whether the economy is strong or weak and whether prices are low or high. For example, a slow or negative GDP growth rate can be an indication that the economy is weak and the overall prices in the market are low, which can be a sign that the accumulation phase is in the making.
After I analyse all these and if the market scored more than 67% on these indicators I form an opinion that the market is in the accumulation phase and act accordingly.
What Is the Mark-Up Phase In the Market Cycle?
This is the second phase in the market cycle, characterized by increasing market activity and rising prices. Investors who have entered the market in the first phase and accumulated stocks will start to see their investments increase significantly in value.
During this phase, old investors continue to buy stocks that they believe are undervalued, with the expectation that prices will continue to rise. This phase is also known as the “momentum” phase, as investors are buying stocks that are already on the rise and new investors also start to enter the market in the late stages of the markup phase. The markup phase can also be characterized by high investor optimism, low volatility, and strong corporate earnings.
It’s important to note that this phase also can be difficult to identify exactly when it starts and when it finishes so always remember to use a combination of indicators and analysis methods, such as news analysis, market sentiment, and economic indicators, to identify the markup phase and make informed decisions.
How Do You Identify the Mark-Up Phase?
You can spot this phase using numerous strategies, one of which will be discussed here; you can build many versions; and always bear in mind that the history and mainstream media can be very helpful to provide a signal when it comes to detecting these types of stages.
Some of the indications you can read to time this stage are presented below, among many others:
Economic Indicators: As stated earlier this is one of the important things when it comes to identifying market cycles, by keeping an eye on economic indicators you can get a sense of whether the economy is strong or weak, and whether prices are low or high. For example, a rising GDP growth rate indicates that the economy is strong and similarly higher consumer confidence indicates consumers are confident in the economy and willing to spend more money can be a sign that we are in the markup phase.
Increased trading volume: Rising enthusiasm among more investors to buy and enter the market can be indicated by an increase in trading volume, which can be an indication of a bullish phase. This increase in trading volume can sometimes reach more than 10 to 100 times the volume during the accumulation stage.
Increased investor confidence: Growing confidence among investors which can be measured by surveys, polls or other research methods, can be a sign that the market participants believe that the market will continue to rise. With this sentiment, many enter the market which helps to push the prices to continue going up.
Rising interest in IPOs: During the markup phase, more companies may go public and issue new shares, because they see the market conditions as favourable and they believe their issue will be subscribed at a good valuation. Companies are more likely to go public when they believe the market will be receptive to their stock. Many stocks’ prices will be high and investors also tend to search for cheap stocks which is why IPOs may be a good option from their side. With IPOs, don’t have a price history and the power of the markup phase can help in pushing the prices up of newly public companies, which can further confirm the presence of a markup phase.
After I look into all these and if the score is more than 70% positive on these indicators I form an opinion that the market is in the markup phase and take strategies and positions accordingly.
What Is the Distribution Phase In the Market Cycle?
The distribution phase is when investors, particularly institutional investors, start to sell their holdings because they form the opinion that the market has reached its peak and that prices will soon start to fall.
During this, there is a decrease in the number of buyers and an increase in the number of sellers, leading to a decline in stock prices. This can be seen in the form of lower trading volume, lower trading ranges and declining price-to-earnings ratios.
It’s worth noting that not all distribution phases lead to a market correction or start a bear market, but they are a sign that the market has peaked and investors are becoming less optimistic about further growth in the market.
How Do You Identify the Distribution Phase?
During the distribution phase of the stock market cycle, you should look for signs like changing market sentiment, the price action of stocks, news etc. Some signals you can track are the following:
Economic Indicators: Indicators like rising interest rates, slowing GDP growth and increasing inflation, can be one signal that suggests slowing economic growth. This is also a warning sign about the distribution phase forming in the market cycle.
Declining stock prices: Many traders & investors start to sell their holdings, and stock prices tend to fall. This can signify that the market is reaching its peak and a correction might be coming.
Decrease in trading volume: The trading volume starts to decline because the sentiment of the traders and investors becomes cautious. They tend to look for buying at lower prices and start to wait which also can be a reason for this. This might be a sign that they are becoming less active and bullish about the market.
High valuations: Due to excessive rise in the price and stable to little growth in the earnings the market’s valuation starts to rise, you can track this with a simple ratio such as the P/E ratio. The P/E ratio of the market or industry can be taken into consideration while analysing this. It suggests that the market is overvalued and that a correction may be coming.
Negative news or analyst downgrades: If negative news or analyst downgrades start to come out, it can indicate that investors are becoming more cautious and less bullish on the market.
What Is the Mark-Down Phase In the Market Cycle?
The markdown phase is the final stage of the stock market cycle and is characterized by a significant decline in the price of stocks. This is also known as a bear market. During this stage, investors become more cautious and less optimistic about the future growth prospects of the market due to the distribution phase already playing out and bringing a big correction.
The markdown phase can start in tandem with the distribution phase as well because more or less both of them have similar signals but their intensity is different. When stock prices have reached their peak and traders start to close their positions and investors start to sell their holdings, triggered by a variety of factors, such as negative economic news, slow growth in the market, increased interest rates, or an upcoming fear of recession.
It is also important to keep an eye on the yield curve, which can provide insight into the direction of the economy and the stock market. A flattening or inverted yield curve, in which short-term interest rates are higher than long-term interest rates, can be a sign of impending economic recession and a potential markdown phase in the stock market cycle. As more selling pressure comes due to these factors it leads to a significant decline in the prices.
How Do You Identify the Mark-Down Phase?
To identify a markdown phase in the economy, investors should look for signs of an economic downturn, such as rising unemployment, decreasing GDP growth, and declining corporate profits. Apart from this, you should also keep an eye on the following:
Negative Returns: Watch for a significant decrease in stock prices over a prolonged period of time like an extended period of negative returns in a stock index, such as the S&P 500. Another signal to watch for is a decrease in trading volume, which can indicate a lack of investor interest in the market. Additionally, investors should also pay attention to the number of stocks reaching new 52-week lows, as this can indicate a bearish sentiment among market participants.
Decreased Consumer Confidence: Another important indicator to watch is the level of consumer and business confidence. During the markdown phase, confidence levels will typically decline as investors become more cautious and less willing to take risks. This can be seen in declining consumer spending and business investment.
Price Actions: In the stock market, a decrease in stock prices, lower trading volume, and a decrease in the number of new highs being reached might signal a markdown phase. Additionally, the number of companies reporting earnings that missed analysts’ expectations may start to increase.
Sectoral Analysis: In addition to the above, you can also look for signs of weakness in specific sectors that outperformed the market during the markup phase of the market cycle, so as to evaluate early signs of change in market sentiment. For example, if the technology sector begins to underperform, this may be a sign that investors are losing confidence in the market as a whole.
In summary, the markdown phase is characterized by a slowing economy, declining corporate earnings, and a decrease in stock prices. Investors should be cautious during this phase and may want to consider reducing their exposure to the stock market.
It is however always essential to consider that the market is a complex system and no individual or none of the strategies is 100% correct when it comes to profiting from investing or trading in the market. You should always plan and implement proper risk measures so that you can be successful. If you want to read more about the market cycle you can study this working paper series by European Central Bank.
Also, this is not financial advice and you should not base any of your decisions solely based on this article. You should do your own research before investing in the stock or any other market. Thank you for reading and consider subscribing to my email list to get notified about future posts and gain your hands on other helpful materials.