In markets, cyclicality is the only reality. A market cycle is simply the period between the last two highs or lows of the index. A cycle can last anywhere between a few months to a few years.
Generally, every market cycle goes through four phases. They inch up, peak, fall down before finally bottoming. This is followed by the next cycle, which goes through the same phases.
Four phases of a market cycle
1. Accumulation Phase
Accumulation can be viewed as the first phase in a market cycle. It occurs after the market have bottomed out. The general mood during this time is that of gloom. Even investors who held on during the bear market in hopes of an upturn quit. On the other hand, value investors, industry insiders get on the bus sensing a healthy opportunity. Typically, this phase is characterised by flattened prices. Many quality companies are available at healthy discounts. As the name suggests, this phase is rife for seasoned investors to accumulate good companies at attractive prices. The markets turn from bearish to neutral in this phase.
2. Mark-Up Phase
In the second phase, markets start showing signs of recovery. The index slowly inches up. There is a sense of cautious optimism in the market. The early investors and technical analysts start increasing their exposure to equities.
Near the end of this phase, we see a surge in investor interest. A fear of missing the bus slowly grips the investors. As volumes increase and valuations soar to all time highs, the value investors begin to exit the market. As the price rise slows, the last leg of investors who were left behind enter the market. Typically, this phase sees markets move from neutral to bullish and finally euphoric. As valuations veer towards a bubble, seasoned investors tend to exit the market.
3. Distribution Phase
In the third phase markets start to slide down as sellers dominate buyers. The bullish sentiment tends to wane, sellers begin to dominate. Prices tend to stay range bound during this time before finally turning.
Investors oscillate between hope and despair during this period. Investors tend to sell off their holdings at break-even or a small loss during the period.
4. Mark-Down Phase
In the final phase in the cycle, markets plunge. People who are still invested hold on their positions to avoid selling at a loss. These are mainly investors who took positions during the maturity of mark-up phase or during distribution phase. Its only when the markets correct substantially (50% or more) do these investors exit the markets. However, this is generally the time when a new cycle begins with an accumulation phase.
Many investors fail to identify market cycles and end up buying and selling at the wrong time. Rather than chasing the quick buck, convince your clients to view investments like long-term plans. Educate them about market volatility and unpredictability to make them see the risks associated with greed.