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Market bubbles are very common, and every time, more people get stuck when a new one comes around. The market cycle refers to the economic trends observed during different business environments. A new market cycle usually forms when changes in market regulations or technological innovations disrupt existing market trends creating new ones. There are four market cycle phases: accumulation, mark-up, mark-down, and distribution. A market bubble is one of several market phases. To avoid getting caught off guard, knowing these phases is essential.
Markets usually move in four phases, as mentioned. Understanding how each phase works and how you can benefit makes all the difference between flourishing and floundering. In the accumulation phase, the market tends to have bottomed as early contrarians and adopters see an opportunity to jump in and enjoy the discounts. In the mark-up phase, the market will have leveled out. In this phase, the early majority jump back in while the smart money cashes out.
In the distribution phase, prices are choppy, sentiments turn slightly bearish, sellers prevail, and everyone recognizes the end of the rally is near. The mark-down phase follows, where laggards attempt to sell and salvage whatever they can. In this phase, early adopters are looking for signs of a bottom to get back in.
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The accumulation phase occurs after the market has bottomed. In this phase, investors and early adopters are beginning to buy because, in their minds, the worst is over. Valuations in this phase are extremely attractive, and the general market is still bearish. During the accumulation phase, all articles in the media would be preaching doom and groom. Those who had gone through the worst of the bear market will have given up and sold their holdings. That’s why prices flatten as almost every seller throws in the towel.
But in the midst of all that, opportunists are picking it all up at a healthy discount. For that reason, market sentiments switch from negative to neutral. During this phase, the selling volumes almost flatten since most sellers will have exited the playing field. Because of the bearish sentiment, there aren’t enough buyers, and institutional investors can step in and fill the gap.
These investors take advantage of the sideways trend and begin accumulating security in loads small enough not to indicate to the market. This is what helps keep the prices low. The accumulation phase is often mistaken for the distribution phase, which comes after the stock decline. This is why you must be cautious, research properly, and wait for a clear break.
The accumulation phase usually occurs following a price fall and resembles the consolidation phase. It has the following characteristics:
The accumulation phase typically forms clear swing highs and lows. The only downside of swing trading is the range might be too tight, resulting in limited profits. The accumulation phase usually doesn’t have a set period when it will break out, ushering in the run-up phase. This comes at an advantage to investors since they have the patience traders don’t have, as the accumulation phase can go on for even more than a year. Most traders prefer adding their securities to watchlists to enter once a clear break occurs.
Since the accumulation phase follows a downtrend that precedes an uptrend and can last for weeks or months, you must have patience. During this period, there’s a price range contraction and never a real edge for day traders. However, you can still take trades during this phase but ensure that you take trades in smaller sizes until a trend is confirmed.
Ideally, longer basing and consolidation periods indicate a market boom around the corner, and that’s when you can be sure the accumulation period is almost over. Any negative news in the media will no longer impact the market. With a more extended consolidation period, all it takes is one piece of information or press release to take a stock out of range and usher in an uptrend in the market.
As soon as the resistance level is broken, you can see higher lows and higher relative volumes pouring in. That indicates that the accumulation time is finally over, and we are in the run-up phase.
The accumulation phase usually begins when institutional investors like pension funds, mutual funds, and large banks buy up substantial shares of stock. Price forms a base as stock shares accumulate. Institutional investors must buy shares over long periods to avoid conspicuously driving up the stock price. This gives them a longer time horizon.
The phase isn’t lucrative for retail investors since most capital will be tied up. Investors also experience large capital drawdowns. Recognizing the signs of the accumulation phase will give you insights into future opportunities. During this phase, prices move sideways in a range.
A good approach when trading is to trade the range itself; go long at the lows and short at the highs of the range. Place your stop loss beyond the end of the range. In the accumulation phase, you are better off going short than long. That’s because there’s no telling when it’s the accumulation phase until it’s over. Trade along the path of resistance or towards the downside. Avoid trading in the middle of the range since the price could easily swing back toward the highs or lows, which could result in you getting stopped from trading at the resistance and support area.
While it’s not always obvious, cycles do exist in all markets. The accumulation phase is one of the most crucial. For smart money, this is a time to buy since the values will have stopped falling, and everyone else is in bearish. Such investors who go against common market sentiments are referred to as contrarians. The same investors sell as markets enter the final mark-up stage, known as the buying or parabolic climax. This is when the market is getting ready to reserve when the values are climbing fast and the sentiment is the most bullish.
Smart investors who recognize the different phases of the market cycles take advantage of each to make a profit. Such investors are also less likely to get tricked into buying at the wrong time.
–Jack Schwager.
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