By Ken Little
Observant investors can find good stocks in just about any market, however it is easier in some situations than others.
A full-blown bear market, when very few stocks are rising is a tough market for investors. Still, this market sets the stage for some great opportunities when recovery begins.
Analysts who study the market’s behavior are fond of breaking the market into four phases. These phases each hold a special opportunity for stock investors.
The most significant problem is identifying which phase is presently in control at any particular moment. The four phases are accumulation, markup, distribution, and markdown.
Think of them as part of a circle that rotates at various speeds. Sometimes we zip through one phase, but are hung up in another.
The Accumulation Phase
The accumulation phase is where smart buyers are bottom fishing for good stocks that have been beaten down in price.
At some point during the accumulation phase the market bottoms out, but that point is usually confirmed after it happens. This may not be a great place for growth investors because there is not an easy or effective way to determine how long stocks will be stuck in this phase.
You could buy in cheap, but sit on a stock that is going nowhere for a lengthy period. This works for value investors, but not others who need something on the move.
The best buys are going to be found in this phase. As this phase ends, prices of leading stocks begin moving up when more buyers
The Mark-up Phase
There is not a sign that says, “the market is now entering a new phase,” so you’ll have to be sensitive to the news. However, during this phase you will see a continuation and acceleration of price increases that marked the end of the previous phase.
One of the indicators that the market is in the next phase is a substantial increase in volume. At this point, many investors who left the market during the dark days of the accumulation phase are coming back in and driving up prices on premium stocks.
Prices will increase through out this phase and accelerate toward the middle and end. You will soon be witnessing the less intelligent money jumping on after many stocks have already posted substantial gains.
Stocks will become over-valued and that will begin setting off technical alarms of a pending price reversal.
As the unsophisticated money moves into the over-bought market, it is time for the investors to plan an exit or take profits. While it doesn’t always happen, the end of the mark-up phase may be capped by an artificial surge driven by unreasoned buying – such was the case toward the end of the dot.com boom in the late 1990s.
The Distribution Phase
The distribution phase is when things begin to turn ugly. Sellers take control and prices begin to fall. Note that this is not an across the board reaction.
Some stocks may not fall as fast as others do. Big cap stocks may hold their prices longer than more volatile smaller cap stocks. If an industry sector is hit with bad news, those stocks may fall faster than other stocks. Fewer stocks are hitting new highs than in previous phases, while the number of new lows begins to grow.
Investors grow increasingly pessimistic, even if there are several false starts that look like the market is bouncing back. Concern drives some out of the market and into cash. This lowers prices even more and the “it’s going to get worse before it gets better” feeling grows.
The Mark-Down Phase
The mark-down phase is when all the wheels come off and prices drop to their lowest. True buy-and-hold investors will be tested during this phase. If their time frame is long enough and they have chosen quality firms, their best strategy is to wait out this phase and hope prices come up as the market cycles through its phases.
Other investors will finally give up and sell, often at a loss. These are the folks who bought near the market top in the accumulation phase and now choose to sell near the bottom. They will complain the loudest about the stock market being unfair.
No one wants to see bear markets, but the fact is there would be no bull markets if there were no bear markets. Bear markets squeeze the excess out of the market and prepare it for the next expansion.
Timing Cycles
A market cycle (all four phases) doesn’t have a fixed length. Some cycles are short, while others are longer. Some categories of stocks may fall into a fast cycle, while other stocks just poke along through one or more phases.
Stocks have their own individual phases and you can see them in charts of various periods. These indicators help traders understand where the market or an individual stock is at a particular moment and what that might mean for future price changes.
When looking at individual stocks, remember that it can jump through a particular phase very quickly. It takes more time for the larger market to move through a cycle, but count on it happening.
When you can identify where the market (or stock) is in its cycle, you have an edge in predicting where it may be headed next.
