As with life, the economy and financial markets have their cycles. Throughout history, it has been said that the market works in cycles. A cycle is a pattern or trend that occurs periodically. The market cycles that occur in a longer timeframe tend to be more reliable than those that occur in a shorter time frame. You can still find small market cycles on the hourly chart, just like you did when you looked at decades of data.
As a market, it is cyclical. Various cycles may affect the performance of some asset classes. Different market conditions can underperform these same asset classes at other times during the same market cycle.
But emotions often hinder us during market cycles. Many of us make mistakes at different stages, buying at the top of the market, and selling at the bottom.
Investors who are successful are just the opposite. Buffett said, “Be greedy when others are fearful, and fearful when others are greedy.“
What is Market Cycle?
Summary
- The term market cycle refers to the economic developments observed during various types of business situations.
- Whenever a new technological innovation or a change in the market regulation disrupts and creates new trends, a new market cycle is formed.
- A market cycle consists of four phases: the accumulation phase, the markup phase, the distribution phase, and the markdown phase.
Different business environments have varying economic trends. A market cycle describes these trends. During a stock market cycle, one or more securities belonging to the same class of assets perform better than others. The prevailing market conditions may be favorable for growth depending on the business model of the securities.
Companies may have high growth rates during a cycle of revenue and profitability. Within one industry, companies may exhibit cyclical patterns, known as secular patterns.
Market cycles: what causes them?
If new technological innovations or regulatory changes disrupt existing market trends, they may cause a new cycle to form. Changes are industry-specific, which means no blanket change in all sectors of the market due to the introduction of new products or a new regulatory regime.
In addition to technical indicators, market cycles also factor in fundamental indicators, such as price movements of securities.
How is a Market Cycle Determined?
Because there are no clearly defined beginnings or endings to market cycles, it is almost impossible for one to determine where they are in. Unlike economic cycles, market cycles have no fixed duration, so they can last for any length of time. It can be a hindrance to monetary and economic policy formulation.
Market cycles usually last for a certain amount of time, depending on their perspective. For example, an options trader might pay attention to five-minute price bars, while oil investors may want to consider a cycle of around twenty years.
It is possible to identify market cycles in retrospect. An average market cycle is defined as the difference between the highest and lowest price of a common benchmark, such as the S&P 500.
Nevertheless, many institutional investors, or even individuals, aim to be ahead of changes in market cycles by identifying them before they occur. In this way, they can benefit from the cycles and place profitable trades. It is the foundation of finance speculation.
Different Phases of a Market Cycle
Market cycles generally exhibit four different stages. During each stage, securities will respond differently to market conditions. As an example, luxury products companies have high growth rates when the economy is in the ascendant.
In a downturn or a recession, fast-moving consumer goods (FMCG) are expected to perform well. This is because the demand for basic necessities and consumer durables, such as food and hygiene products, remains constant.
The four phases of a market cycle are as follows:
1. Accumulation phase
Accumulation occurs immediately after the bottom is reached on the market. Once investors and money managers begin to buy securities, valuations become increasingly important. As the period progresses, the market sentiment switches from being negative to being neutral. Despite this, the market remains bearish.
2. Mark-up phase
The markup stage is characterized by large influxes of investors, which contribute to a substantial rise in market volumes. Although valuations begin climbing above historical norms, layoffs and unemployment continue to increase.
During the mark-up stage, the market sentiment changes from neutral to bullish, and even euphoric in some cases. During a selling climax, hesitant investors and fence-sitters participate, which causes a last parabolic price rise.
3. Distribution phase
During the distribution phase, traders begin to sell securities. It goes from a bullish to a mixed market sentiment. A market direction change occurs at the end of this period.
It might take some time for the transition to take place. Over several months, prices tend to remain more or less constant. This can happen, however, if a sudden political or economic event, such as a pandemic lockdown, results in rapid acceleration.
4. Mark-down phase
Investors who still hold positions suffer during the mark-down phase of a market cycle. The prices of securities fall far below what investors originally paid for them. During this period, new investors will purchase the depreciated assets. It is the last phase, and represents the beginning of the next accumulation stage.
An economic cycle lasts between 28 months and more than ten years. Typically, the stock market cycle forecasts the economic cycle six to twelve months ahead. The cycle is familiar. Similarly, we feel different emotions at different stages, as well as what we want to do and what we should do. Moreover, the new cryptocurrency market cycle will have new data and methods to produce its own cyclical changes.
Regardless of market volatility, it is important to develop an asset allocation plan that can be rebalanced to achieve a combination of stocks, bonds, cash, and even cryptocurrencies. When you follow this plan, you can often take advantage of buying low and selling high, a process that requires self-discipline.
