A Stock Market Cycle is often associated with the Business Cycle.
The Stock Market Cycle has four distinct phases:
These 4 Phases are then followed by the next Accumulation Phase and the whole cycle repeats itself - albeit, never exactly the same.
The 4 phases are depicted in the diagram below. It all starts with a rush of optimism. Followed by enthusiastic excitement and "the thrill of the kill."
The roller-coaster ride follows a sine wave type of movement before ending up where it began. Ready to make a new cycle.
The Stock Market Cycle begins after a severe Bear phase.
Amateur investors think that the markets are in free fall. Every chance they get they off-load their stock onto willing buyers.
These willing buyers happen to be professional traders who know that the market is at, or near, its low point. This buying up of stock by professionals (strong holders) from the amateurs (weak holders) can happen over several weeks. Months even.
The amateur investors see what they think is a rally before the next downturn and eagerly sell their shares thinking that prices could go a lot lower. They've lost faith and panic has set in.
There will, however, come a time when prices stabilise. At this point buyers (the professionals or strong holders) gobble up what supply there is available. Simultaneously, sellers (the amateurs or weak holders) are only too glad to get rid of what they believe is a rotten apple.
This phase of the cycle is called the Accumulation Phase. Professional traders are accumulating all the supply of stock at what they know are bargain prices.
This buying and selling goes on until there is no more supply available. How do the professionals know when this point comes?
The Market Makers will test the market. They do this by marking the shares down sharply. If there is little, or no selling the professionals can see this from the market test.
This is their signal that the "Accumulation" phase is now over and the stock is ready to go only one way. Up.
See also Selling Climax.
At the end of the Accumulation phase the stock breaks out. And it doesn't take much buying for it to move up. Prices can, and do, move up on thin volumes. The professionals did all of their buying at the bottom - in the Accumulation phase.
As prices move up, the amateurs begin to take notice. They don't want to be left behind. The prices go up and up and the un-informed investors pile in.
This "buy at any price" approach eventually reaches a peak where un-informed investors (weak holders) think the market is going to the moon. Of course, the informed investors (strong holders) can see exactly what's going on. They've seen it all before.
But up and up go the prices as the amateur investors buy, buy, buy. Even the professionals may buy on pull-backs.
This phase of the process is not called "mark up" by accident. Market Makers are literally marking up prices. Volume on some days may be low. But Market Makers have got to balance their books for the day.
The Professionals can see the peak
just on the horizon and begin to sell their holdings to weak holders or mug punters as they are sometimes called. (We should know - we've been mugs quite a few times in the early days).
This selling process is the next phase of the cycle and is called the Distribution phase.
Professioals are distributing their stock to the weak holders. As was the case in the Accumulation phase, this Distribution could takes weeks, or even months to accomplish.
By the time they have dumped all their stock onto these weak holders, there is no more real supply available and the market has only one way to go. Down.
At the point of Euphoria, the Market Makers will even mark up stock in an attempt to "test" the market if there is any demand. This "test" is the exact opposite of what happened at the end of the Accumulation phase. If they see low volume at this point, they then know that supply has dried up.
See also Buying Climax.
Phase Four of The Stock Market Cycle sees a strong mark-down of prices.
As the market turns, weak holders are still thinking that this is just a small correction. Which it may be. But not for long. For all the short rallies on the way down, there are sharper declines. The market is now definitely in the 'Mark Down' Phase.
The mark-down is accompanied with rallies, which bargain hunters think the market has bottomed. The professionals have seen all this before and even buy on these rallies knowing full well that easy profits are to be made in short order.
The weak holders think this is just a market correction. But every time the market rallies the dips get larger and larger. It's not long before the weak holders begin to panic. They think that the market is going to crash.
The professionals bide their time. They may even disappear and play golf or whatever. Keeping one eye on the markets of course.
Then, after a time, the market has fallen so far that the weak holders do more than panic - they are distraught. They begin to dump their stock onto the market. They've had enough - never to return.
We think it was P.T. Barnum that said: "There's a customer born every minute."
And so it goes. Around and around. A new set of amateurs will soon enter the arena.
But the professionals will always be around. They know how to play the game.
And the next phase of the Stock Market Cycle is the Accumulation phase.
The whole process just repeats itself.
This next time around will never be exactly the same as the last, but it will be similar:
And, and, and.
Your next question may well be: "But how do I identiify at what stage of the Stock Market Cycle we are currently at?"
Great question and the only answer we can give you is that you can, with experience, begin to recognise patterns. That's why we have a section of this website about Technical Analysis.
It's also where we differ from Warren Buffett and Charlie Munger. We need to look at charts and diagrams. We are not as clever as those two guys. But what's to say they don't have a picture going on in their minds.
But there is one question: "How long does a Stock Market Cycle last?"
And there's no right answer to that question. Stock Market cycles can last for minutes, hours, dys, months, years, even decades.
The basic Stock Market/Busiess Cycle generally lasts about four years.
But there are different cycles than just the Stock Market Cycle and The Business Cycle.
For example, there is the four year Presidential Election Cycle in the United States, the Kondratiev Cycle which lasts for 60 years, war and peace cycles, options expiry cycles and there are many others.
Statisticians come up with all sorts of events. For example, how the S and P 500 performs in January depends on how the S and P performs for the rest of the year.
Historically, the best months of the year to invest are November through to January (February generally being the worst month of the year), April being the best.
Stock Market Cycles do occur, but identifying them at the time is easier said than done.
Like a lot of things in life, it all seems so obvious after the event.
But the whole point of studying a cycle is not so much to be able to spot exactly what is going on, because it is difficult to do that, but rather to understand what is going on.
We all know that after a Bear Market stocks recover. History has taught us that. But here at Common Sense Retirement Investing, we are not Day Traders. And neither should you be.
We are long term investors.
What would Warren Buffett and Charlie Munger think about cycles? They wouldn't try to analyse them in minute detail. But you can bet your bottom dollar that with their cash reserves, they will be sat in waiting for the Accumulation Phase where they will fill their boots with bargains.
But, unlike the majority of investors, they will not bail out at the Distribution Phase. They have stated many times over that they are in it for the long term. As in - forever.
We do not have their deep pockets and that's where we tend to differ. We do sell at the top of a Bull Market but buy back again, hopefully, at the bottom.