The stock market is well known for its volatile moves. But did you know that there are 3 distinct phases of the stock market? Understanding these phases can help you to make some strategic picks and allocation of your stocks. This can also protect you from investing during the wrong times and selling during the wrong times.
According to Dow Theory, a primary bull market has 3 stages. They are – Accumulation, Big Move, and Excess. Similarly, a primary bear market has 3 stages – Distribution, Big Move, and Despair.
The 3 Stages of Primary Bull Market
#1 Accumulation: This phase starts when experienced traders and institutions enter their positions. Typically, this would happen at the end of a downtrend. Since only informed investors are entering their positions, the price moves would be slow.
Many regular investors would not be able to identify accumulation phase as they would think that the bear market is like to continue further. However, if you identify this phase quickly, you can enter the market when the price is low and maximize your profits.
Some of the clues that can be used to possibly identify accumulation phase are
- Divergences on momentum indicators
- Broken consolidation channels implying breakouts,
- IH&S (inverse head and shoulders) patterns etc
#2 Big Move: This phase is kicked off as soon as the accumulation phase gets over. The new trend starts to become obvious in this phase. There would be an influx of new investors now, driving the prices higher. Therefore, it is also called as the public participation phase. This is the phase when the momentum traders and trend-following traders enter positions. The ‘big move’ phase is usually the longest phase.
#3 Excess: After the big move phase, the excess phase comes in. The price surges further in this phase due to euphoria and irrational optimism. This results in a bubble-like behavior. This is the phase when the smart money investors start to quietly unload their positions.
The clues that can possibly point to identifying this phase are
- increasing volatility
- significant downward pressure
- deeper pullbacks
The 3 Stages of Primary Bear Market
#1 Distribution: This phase starts when experienced traders and institutions enter short positions. This is done after they finish unwinding their long positions. Typically, the market would be overbought in this phase. However, regular investors usually do not understand that it is the distribution phase and instead, consider it as a bullish phase.
Some of the clues for possible identification of distribution phase are
- prolonged concentrations
- head and shoulders patterns
- price making lower lows and lower highs
#2 Big move: By this phase, regular investors also begin to understand that the trend is down. The business conditions worsen and the sell-off would continue in this phase, bringing the price down. This is the longest phase of the primary bear market.
#3 Despair: This is the third phase wherein regular investors let go of all hope and prices fall further. The market usually continues this decline until the bad news is fully factored and stocks are priced accordingly. This is when the stocks hit rock-bottom, after which the cycle starts again! The accumulation phase of a primary upward trend will begin again at this point.
The figure below shows these phases…