Regardless of whether you are a long term investor or short term trader it is essential to understand market cycles in order to know when to take profits and put effective risk management strategies in place. These are the basics I wish I knew before I started my investment journey.
Market Cycles refer to the cyclical, recurring patterns or highs and lows in financial markets (I.e., The repetition of bull and bear markets/this perpetual cycle). These cycles are driven by various factors including economic conditions, investor sentiment, and market psychology. The stages in the market: 1. Recovery (Early Bull Phase): After a period of recession or economic downturn, the market starts to recover. Economic indicators such as consumer price index (CPI data), unemployment, Gross Domestic Product (GDP) show signs of improvement, and investor sentiment becomes more positive. During this period, stock prices and other asset prices begin to rise, and trading volumes increase. 2. Expansion (Mid Bull Phase): In this phase, economic conditions continue to improve, leading to increased corporate profits and business expansion. As a result, the stock market experiences sustained growth, and investor confidence remains high. This phase is characterised by a strong bull market, with prices steadily rising. 3. Peak (Late Bull Phase): The peak represents the highest point of the market cycle. At this stage, the economy is generally performing well, but assets appear to be overbought. Stock prices reach their highest levels/peaks, and optimism/greed among investors may reach excessive levels. This is often when speculation and euphoria are prevalent. 4. Contraction (Bear Phase): After the market reaches its peak, a correction or downturn follows. Economic growth may slow down, corporate earnings might decline, and market sentiment turns negative. Investors become more cautious, leading to a decrease in stock prices. This phase is known as a bear market. 5. Trough (Early Bear Phase): The trough marks the lowest point of the market cycle. Economic indicators are weak, and investor confidence is low. Stock prices and other assets hit their lows, and trading volume often drops. This is often a period of pessimism and fear among investors. 6. Recession (Mid Bear Phase): If the economic conditions continue to deteriorate, the market may enter a recession. During this phase, corporate profits decline significantly, unemployment rises, and economic activity contracts. The bear market continues as stock prices remain low. Quantitative easing could be introduced. 7. Recovery (Late Bear Phase): As the economic conditions stabilize or show signs of improvement, the market starts to recover from the bear phase. This is the transition phase between a bear market and a new bull market. Investors begin to see opportunities in undervalued assets, and buying interest increases.
Warren Buffett — 'Be Fearful When Others Are Greedy and Greedy When Others Are Fearful'
Obviously it would be optimal to buy the lows, and sell at the highs but it is near impossible to time the market and often our emotions get in the way. Although you can spend all your time trying to gauge market sentiment on twitter and reddit, analyse CPI data, and do technical and fundamental analysis, it is essential to remember that the only thing predictable about the market is that it is unpredictable, no one really knows what the fuck is going on and it is a model that is based off human emotion and psychology. Humans are irrational; therefore the market may seem irrational. We can attempt to predict market psychology, predict the markets and build models around it but the reality is no one really can predict what is happening therefore it is imperative that proper risk management is utilised and in place. The stages 1-7 above in the market represent a simplified model of market cycles, however in reality the duration and intensity of each phase can vary widely. Market cycles can also be influenced by external events, politics, geopolitical developments, changes in monetary or other policies, and technological advancements (this all falls under the umbrella/realm of fundamental analysis). Trying to time the market (highs and lows) based solely on these cycles is challenging and risky. (Therefore, when long-term investing it is important to dollar cost average into any investment). Market timing is notoriously difficult even for experts and long-term investment strategies that consider individual financial goals, risk tolerance, and diversification tend to yield better results over time.
