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What Are Market Cycles and How Do Traders Use Them?Financial markets alternate between periods of decline and growth. They are related not only to the economy, but also to the psychology of investors. Many investors try to analyze the cycles of the market in order to obtain higher profits. Let's take a look at what this is.
What are market cycles?Market cycles are patterns or trends that tend to form over time in various markets. They represent the period of time between two minimum or maximum price points. New market cycles usually arise when trends form in a particular sector or industry due to some kind of innovation, new product, or regulatory change.
The length of a market cycle can vary from a few minutes to several years, depending on the market. There are different aspects of the cycle: for example, day traders focus on intervals of 15 to 60 minutes, while real estate investors look at periods of up to 20 years.
Understanding Market CyclesCycles in the markets exist primarily because there are cycles in the economy.
However, there are other reasons. The economic cycle affects not only the profitability of companies, but also the psychological mindset of investors. They rarely hold rational and stable positions. When markets rise, investors are bullish and willing to take risks. They buy stocks and prices go up. However, the mood can change, then investors start selling and the price of the stock falls.
Phases of a Market CycleThere are four phases in each market cycle:
This is the first phase of a market cycle. Accumulation begins after the market has bottomed out in the previous cycle. As demand grows, prices can no longer form new lows. Consequently, the downtrend begins to lose momentum. The market turns bullish.
In the mark-up phase (increase), the market begins to consolidate. Prices start to rise and the market attracts a large number of buyers who want to join the new uptrend at an early stage. Bullish price trends push prices to new highs. First-time buyers take advantage of high prices to capitalize on their first investments. Traders are also taking advantage of the uptrend at this time.
In the distribution phase , the market experiences a sell-off. However, prices remain stable for quite some time. This is due to the equal distribution of buyers and sellers in the market. The bullish sentiment at the mark-up stage is beginning to fade and no new highs appear. Investors who have not entered the market are left out. This is a good time for investors to sell assets as prices have peaked.
This is the final phase of a market cycle. In the mark-down phase, large investors begin to sell their investments to secure their profits. The rest of the participants follow quickly. When prices fall in a downtrend, market sentiment becomes more bearish. Investors who entered the market when prices were at their peak will hold on to their investments in the hope that prices will rise. Unfortunately, prices continue to fall. This is a signal to investors who can determine the end of the downtrend to make further purchases. When that happens, the accumulation phase begins and a new market cycle forms.
Related: Top Stock Investment Newsletters
Types of Market CyclesThere are different types of market cycles. Let's consider the main ones: universal (Wyckoff market cycle), Wall Street market, Forex market and real estate market cycles.
Wyckoff Market Cycle
There are four stages in the Wyckoff market cycle: accumulation, mark-up, distribution, and mark-down.
The Wyckoff Market Cycle is based on price observations, key moments of trend development, and periods of accumulation and distribution. Although the Wyckoff method originally focused solely on stocks, it is now applied to all types of financial markets.
The Wyckoff market cycle consists of four main phases: accumulation, mark-up, distribution, and mark-down.
Forex Market CycleThere are many types of Forex cycles and their types and features are not limited to any one parameter or time frame. Let's look at one of the most common Forex tightening and easing cycles which has four phases: boom, peak, trough (or contraction) and trough.
The first phase of the cycle is expansion. During this phase, the market rebounds from previous lows. The interest of market participants in the asset increases. And they start to act: they buy in an uptrend or sell in a downtrend. The more active the participants, the faster the trend develops.
Next is the peak phase. Economic indicators such as production and sales volumes, employment, etc. they are at their highest point and they are no longer rising. At this stage, the trend has exhausted itself and its rapid growth or decline begins to stop.
Then comes the recession. Stocks are already falling, and commodities are also starting to decline in anticipation of falling demand as the economy weakens. At this stage, investors close their trades.
The final phase of the trend cycle is the trough. The peculiarities of this phase are the relative calm of the market and insignificant changes in prices. During this period, the market is gathering strength and consolidating after the recession. Economic conditions are no longer deteriorating, but the economy is not yet in an expansion phase.
Wall Street Market CycleWall Street market cycles are similar to Wyckoff cycles. They are also based on the accumulation, mark-up, distribution and mark-down phases.
There are four emotional stages of the Wall Street market cycle on the chart: stealth, awareness, mania, and explosion.
The first phase is similar to the accumulation phase in the Wyckoff cycle and is called the stealth phase. In this stage, prices slowly rise and moneymakers identify the best buying opportunities.
The second phase is awareness. Prices start to rise again, but investors are not letting their guard down. If they decide to enter the market again, they do so cautiously.
At the top of the market cycle is mania, the point of maximum financial risk. This is the time when investors think that nothing bad can happen. Thus, a self-sustaining cycle is formed: more and more investors enter the market hoping for incredible profits, leading to further price increases and capitalization reaching dizzying heights.
Then the bubble bursts and the market enters a burst phase. As uptrends are replaced by downtrends, investors lose hope and start to panic. They no longer trust their actions and are trying to minimize their losses. Some of them finally get discouraged and no longer believe that the market will recover.
Real Estate Market CycleThe real estate market is particularly cyclical because supply often fails to keep up with rapidly changing demand. The cycle consists of four main phases: recovery, expansion, hypersupply, and recession.
Recovery is where the market begins to revive after a downturn. The number of transactions gradually grows and the proportion of unclaimed real estate decreases: the demand begins to absorb the excess space created during the expansion phase.
The expansion is driven by economic growth and the increase in the purchasing power of the population. The market cycle enters this phase when the level of unclaimed real estate falls to a minimum and, on the contrary, the interest of buyers increases. At this point, investors begin to actively invest in the construction of new projects to meet the increased demand.
At some point, investors stop paying attention to the inflated cost of land or the projects themselves, believing that further increases in prices and rents will recoup their costs. This is when property prices on the market begin to significantly exceed the real purchasing power of the population and businesses, and the number of transactions begins to decline.
At the same time, the construction that started during the expansion period cannot be stopped overnight and the market becomes oversaturated, which can lead to the formation of a bubble.
The recession manifests itself in a fall in prices and rents, which is influenced not only by reduced demand, but also by the growing proportion of unclaimed real estate. During a recession, investors freeze new projects and construction rates fall.
ConclusionUnderstanding recurring market cycles is a necessary skill for any trader. Cyclical analysis experts believe that only with the help of cycles is it possible to see in advance which direction the market will go. Whether true or not, one thing is certain: it is possible to increase the efficiency of market forecasting with the help of cycle analysis.
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