Below is an illustration and explanation of stock market cycle going through 4 different levels. If you can recognize the level of the stock market cycle, you can become a profitable investor no matter what level the market is in.
Amazon Inc, Source: Google
The stock is pretty quiet, it doesn’t go up – it doesn’t go down, it crawls more-less horizontally and you feel like time goes slower. This is where supply and demand are equally holding its position of the price; in other words: there is the same number of buyers and sellers. Many people got smashed by the previous bear market so they’re not able to keep their positions, another group of traders is scared of a market going even lower and generally, these aren’t positive about the stocks. However, there are other investors who are able to hold it and who see a potential in the stock, since it goes at a low valuation. These investors understand the fundamentals of the industry and they are often insiders or money managers who can recognize the bottom and are willing to wait for their bull market. A mixture of all these market participants makes the stock to go sideways and keeps level 1 to last from few weeks to several months.
During the level 1 period when stock touches its high, there is an opportunity for sellers to get rid of it until there are no more sellers. Here comes time to invest – to buy the stock. This is a time when demand is higher than supply when there are more buyers than sellers. A great indicator to spot this moment is when the stock crosses its 200-day moving average. The stock is no longer going sideways, it goes up on the chart and this lures the public to step in. People get positive about the stock market, most of them see there a potential to make a lot of money. As all the excitement comes along, the line on a chart climbs upwards creating a bull market. During this period, the stock experiences several pullbacks – these are moments when the price goes slightly down for short period because some traders who bought early enough want to take their profits and invest maybe elsewhere. This is a great opportunity to get in and buy the stock. The ideal situation is to buy at the first pullback of the stock’s bull market.
Every mountain has got its top, for the stock market cycle, it comes when there is no more money available and the number of buyers starts to decrease, demand and supply find its equilibrium. The stock starts to go more less horizontally on the chart again. The institutional investors take advantage of high valuations and sell the stocks to take profit, while the public and novice traders buy the stock because they believe the stock will up more and more. People don’t look at the fundamentals, on wider markets or important economic indicators. There is still a lot of excitement about the bull market when the public is buying expensive shares until there’s no more money, no more buyers to drive the market higher. At this point the last ones who see what’s happening in market sell, prices start to go downwards. 200-day moving average starts to draw above the stock price.
Inexperienced investors don’t know when the market reached its top, they still live in their dreams making a lot of money. Many buyers see it as another pullback as another market correction. People watch TV or read on the internet how CEOs and other clever people recommend the stocks and ensure us about the market being fine. However, as the bear market begins, novice traders are not able to hold their positions anymore, they start to panic and they get out losing. They blame bankers, government, other markets or whatever else that happens during these bad times to convince themselves that they were not wrong. Many people are frustrated and want to no more invest in equities. The stock becomes quiet, low volume and eventually starts to build its base again, if not bankrupt or acquired.
The stock market cycle is an important overview of market behavior in the long-term picture. A correct recognition of individual levels gives the investors a favorable opportunity to spot a trend and adjust with the trading strategy.