Trading the Financial Market Cycle

Submitted by Marco Palmero on 22 January, 2009 - 10:00

Financial Market Cycle

We’ll examine trading the financial market cycle – a continuation of the discussion from here. There are four stages to the financial market cycle: The first stage of the stock price cycle is “Indecision”. Stage two is indicated by a rising trend pushed up through greed and market euphoria. Stage three is another period of indecision. Stage four is a period of time where prices fall and the market is gripped with fear and panic. Then the cycle returns to stage 1. For those who are in the know – I’m not talking about Elliot Wave theory here (aka the 5 wave pattern) We’ll leave that discussion further down the road. Here we’ll be focusing on economics 101.

The first stage of the market cycle, which may happen on long term weekly charts or short term daily or intraday charts, is indecision. This period of time can last for seconds, minutes, weeks or months – depending on how you look at your charts – what time period, and for what purpose (investing or short term trading). Indecision is demonstrated by a sideways movement in price. You’ll probably hear market commentators saying the stock price is consolidating, or is in a tight trading range or is “basing”. You may even hear that the price is “hovering around support.”

The second stage is triggered by a breakout. This new uptrend shoot is a result of the period of indecision in stage 1, where it has reached a period of time when buyers are keen to get some action. Why? It could be a number of reasons – good news, fundamentals, key technical point, industry cycles – anything can spur a buying trend and urge the market participants to start paying higher prices. Greed drives more and more demand, pushing the stock price higher.

Stage three is characterised by a period of indecision after a slowing in the increase of the stock price (which also means the strength of the demand from the buyer is reaching an equilibrium with the price being sought by sellers). The uptrend is broken and the stock begins to trade sideways at the peak of the cycle. Depending on how you look at it, at this point in time the stock can do three things – keep trading sideways in a trading range until something substantial comes along, keep rising if the good news and demand keeps rolling in or as it’s depicted in your diagram – it can fall if fear and panic overcomes the stockholders.

When the market price starts retreating from the peak, stage four is realised. Stage four is characterised by a falling share price and the shareholders fear and panic as they lose stock value. Stage four is the domain for short sellers. It is also the domain for losers – where people can make the mistake of averaging down – or trying to pick a bottom.

These four stages of the financial stockmarket may be really simple to learn, but they are the basics of market machinations. This is the theory that you need to know and master – so that one day your market intuition will be an unstoppable force in extracting money from the markets.