One complete market cycle consists of four phases: market bottom, bull market phase, market top, and bear market phase. The core element to trading successfully is knowing where you are in this cycle. Each phase of the cycle is marked with distinct technical and emotional characteristics.
During market bottoms, traders and investors are typically exhausted from the stresses of the past bear market. They become ambivalent to the market. This ambivalence is reflected in low average daily volume, narrow price ranges, and low volatility. Many exit the market during this phase, placing their investment capital in fixed income instruments. The market stops selling off on bad news and begins to heal. This is a good time to sell trading range highs and buy trading range lows. Traders may have to drill down to smaller time frames where volatility is sufficient to cover expenses and produce a profit. Once the trend lines of the bear market are broken, bottoming patterns emerge: v bottoms followed by consolidation, double and triple bottoms, reverse head and shoulders, cup and saucers, etc.
The bullish trending phase begins officially once the market or individual stock has made two higher lows and two higher highs. This phase is marked with increasing greed. The market will climb a wall of worry to ensure it doesn't miss out on the next move up. Ideally, you want to see greater volume during rallies and lighter volume on retracements. Pull backs typically are 50% or less and find support at previous highs. Traders who missed out on the latest move will typically enter at these support areas. Short term moving averages slope upward above longer term moving averages. Negative news is muted and less frequent. Earnings surprises fuel explosive moves to the upside. Continuation patterns are profitable: pull backs, trading range break outs, pennants, flags, etc. Trend lines stay in tack with at least a 45 degree angle.
The topping phase often begins with one last explosive move to the upside, making a new 52 week high and creating an overbought condition, a high volume climax ending with a topping tail. Those who got on board the bull market during the climax are quickly underwater. They become uncertain about their bullish decisions. As late comers soon jump ship, smart money takes profits, the bears come out of hibernation. Earnings warnings and misses embolden the bears further. The market whip wildly to the downside on bad news and whips wildly to the upside on good news. The market is uncertain if the bull market has another leg up. Moving averages are flattening out and trend lines are broken. Topping patterns emerge: Double and triple tops, topping tails, island reversals, head and shoulders. break out failures, etc. Look for trading ranges to buy bottoms and sell tops.
Uncertainty evolves into fear as news reports worsen. Lines of major support are broken as profits are taken and bears go short. The bear market phase is official when two lower highs and two lower lows are in place. Good news becomes muted and less frequent. Good companies are sold off with the bad. Down volume explodes, rallies are short lived on light volume. The trend line of bear markets are much steeper than the up trend of bull markets. Fear is a much stronger emotion than greed. It is like yelling fire in a movie theater. Sell break downs from sideways patterns and sell all replacements to minor resistance. Avoid going long!
The bear market is nearing its end when one last multi-day sell off creates an over sold condition. The market runs out of sellers. Stocks have become difficult to borrow for shorting purposes. This climactic sell off typically ends with a large bottoming tail on high volume. This final multi-day sell off leaves a price void above that presents a short term buying opportunity. Often these robust rallies end with a retest of the market low, trend lines are broken, and the bottoming phase begins a new market cycle.
The art and science of Technical Analysis contains many valuable tools intended to help traders and invetors improve their odds. Visit http://www.learnstockmarket.org to learn about technical analysis, trading platform reviews, stock chart analysis, and market news.
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