Traders or Investors, everybody likes to see the chart to know where their stock company stands. But analyzing the chart without understanding the basics of market cycles leads nowhere. It is a mandatory task to know about the market cycle before you go long or short in a stock. This article covers the four major types of market cycles.
Trending – The term “Trending” has become popular these days since Twitter takes control of most of us. In the stock market, trending means a stock moves in a direction actively either in uptrend or downtrend. If stock market trends, it indicates the stock has full support of bulls/bears. You can win most of the time when you enter the stocks in trending phase.
Consolidation – It is a bit of boring phase. The stock starts to move sideways, indicating both the bulls and bears are unclear about the company’s direction. The stock remains in consolidation phase until good or bad news flows in the market. Though it is in an unclear phase, there are also traders who love to jump in consolidation phase. In consolidation phase, the market is likely to move between the known support and resistance level. Pro traders take advantage of it and build a system that works in consolidation phase. Usually their system gives buy signal at support level and sell signal at resistance level. I suggest traders not to get in a stock at consolidation phase as the stock may remain in this phase for many months. This phase is not suitable for swing traders as they primarily look for riding the trend.
Breaking point of Consolidation phase – This is the area where we need to focus because, if consolidation phase breaks, it indicates either bulls or bears are going to take control of the stock for a while. After a war between buyers and sellers, one of them would decide to give up and that’s the point where the other party dominates; it is called as Breaking point of Consolidation phase
Correction – In trending phase, suddenly you can see a short and sharp reversal mode of the primary trend and that is called as Correction phase. Correction phase occurs due to profit-taking factor, greed factor, when some of the traders/investors feel it’s overvalued. It seems stock is likely to go in opposite direction of the primary trend but actually it rests for some time and follows the primary trend. Elliot wave analysis can help us identify the correction waves in the chart.
Why is it necessary to understand the market cycle
If you judge the market cycle incorrectly, the result costs more. For example, Investors can stay in consolidation phase for years but consolidation phase will not help traders in any way as it consumes most of our time. So, when you have a trading system in place, check if your system can adapt in all of the market cycles Trending, Consolidation, Breaking point of consolidation, Correction.