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Trade Less, But Wisely; Get Rich Step by Step
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What is Market Cycle ?
Prices of any asset may appear to move randomly up and down. Technical analysis shows that there are distinct repetitive cycles that occur in market of every asset. When we talk about market cycle, it refers to the period between the two latest highs and lows of a common benchmark of the financial market. In simple words, it refers to the phases in which the price of any security, commodity, bond, currency etc. moves.
There is a well-known saying: "We cannot direct the wind, but we can adjust the sails" A good sailor knows better from which direction of the wind is coming and with what speed it is coming. In the same way, if a trader understands different stages or phases of market and price movement during these phases, he can identify new trading opportunities and lower his trading risk. A trader who recognizes different phases of market is able to change his style of trading accordingly and can definitely remain profitable in his trading in a broad way. The study of market cycles or phases helps the trader to know in which way the majority of the market participants are trading in securities.
Market cycles are divided into four distinct phases :
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Accumulation / Expansion Phase
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Mark-up / Advancing Phase
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Distribution / Contraction Phase
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Mark-down or Declining Phase
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Accumulation / Expansion Phase :
Accumulation or expansion occurs after the market has bottomed out and traders begin to buy assuming that the worst is over. In this stage, people start accumulating security when it is trading in a particular price range. Thus, accumulation is the period of consolidation after the completion of downward trend, but before an uptrend starts. The most important feature of this phase is that there is an increase in volume of trading, but price remains range bound. High volume in trading and range bound price movement after the completion of down trend indicate that market participants start becoming bullish in accumulation phase.
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Mark-up / Advancing Phase :
Once the security breaks the accumulation stage, it enters into mark-up or advancing phase. During this stage, market remains stable, but price gradually starts making higher highs and higher lows. As this phase matures, more and more traders and investors jump in. It signifies that emotions like greed steps in and fear is eliminated among the investors and traders. After breaking out from well defined range of accumulation phase, when price keeps rising, it indicates that those who remained silent during accumulation phase are now aggressively buying the security. Such a breakout is also accompanied with high volume in this advancing phase.
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Distribution / Contraction Phase :
Distribution or contraction phase occurs when the security starts losing its momentum and people starts booking profits. The strength which was earlier strong during mark-up or advancing phase starts weakening during distribution phase. Market participants become cautious, starts booking profits and some are even create short positions in security during this phase.
Just like accumulation phase, here also in distribution phase, security starts trading in a well-defined price range, moving between upper and lower band of the consolidation. High volume in trading and range bound price movement after making a peak indicates that the market participants have become cautious and are less interested in buying the security.
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Mark-down / Declining Phase :
Once the price has broken out from the distribution or contraction phase, mark-down or declining stage occurs. At this stage, traders who had earlier bought the security start to exit their positions. The important feature of this stage is that trading volume is accompanied with a sharp decline in the price during this phase. The weakness which was built up during distribution or contraction phase now increases further more, breaking down the price from the well defined range established. Those who remained silent during distribution phase now start selling aggressively and hence price makes new lower lows and lower highs during this declining phase.
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Trading Environment - Trending Market & Ranging Market
When two people go to war, the foolish man aways rushes blindly into battle without making any plan, much like a starving man at his favorite buffet dish. While the wise man, on the other hand, will always get a situation report first to know the surrounding conditions which could affect his activities in battle and then starts his real role in battle.
Just like warfare, a trader should get a situation report on the trading environment. Means he needs to know in what kind of market environment he is actually going to trade. By knowing the market environment, a trader can choose a trend-based strategy for his trading. A trader should always look at historical price movements to study the behavior of the buyers and sellers which helps him to take the best possible course of action. In other words, before entering into a trade, a trader should identify whether the market is trending or ranging i.e. whether it is in uptrend or downtrend or sideways trend.
When market is in an uptrend or in a downtrend, it is said to be a Trending Market, while when market is neither in an uptrend nor in a downtrend, but remains sideways, it is said to be a Ranging Market.
Trending market is one where prices are moving in one direction, either up or down. It may have some small correction or pullbacks (retracements), but looking at the longer time frame, overall market more or less is found in a defined direction only.
When price of a security makes a series of higher highs and higher lows (HH & HL structure), it is called an upward trending market. An uptrending market signifies that people are ready to buy not only at higher prices but also ready to buy at every dip. In uptrending market, when a trend line is drawn by connecting recent higher lows, it is in upward sloping direction.
Similarly, when price of a security makes a series of lower lows and lower highs (LL & LH structure), it is called a downward trending market. A downtrending market signifies that people are ready to sell not only at lower prices but also ready to sell at every rise. In downtreding market, when a trend line is drawn by connecting recent lower highs. it is in downward sloping direction.
Along with studying the market structure about highs and lows made, many traders give importance to Moving Averages to determine the trend of the market. They use different period moving averages like 10 period, 20 period, 50 period, 100 period or 200 period.
While plotting these averages, when smaller period moving averages fan out or spread out on the top of the larger period, price is said to be trending up. Similarly, when smaller period moving averages fan out or spread out below the larger period, price is said to be trending down. Larger time period moving averages are used as trend filtering criteria for analyses of longer period.
Ranging Market is a situation when price consolidates within a range. During such consolidation, price moves between a specific high and low for a number of times. In such cases, the high price acts as a major resistance in which price can't seem to break through. Likewise, the low price acts as a major support in which price can't break as well.
Resistance prevents the price to rise any further and support prevents the price to fall any further. Buyers and sellers are said to be in a balance and equilibrium in ranging market. Ranging Market is completely opposite of trending market.
Ranging market is also known as a "choppy market", just like choppy waves in the ocean. In a choppy market, there is not any clear direction, and the price just "chops around" or "chops up and down" and trades within a very narrow range.
In case of ranging market where price moves between specific high and low level for a number of times, we can easily draw almost horizontal support and resistance lines or zones on a chart. The volume dries up when the price goes into consolidation phase as compared to when it was in trending up or down.
In the ranging market, when the price breaks through either support or resistance, it paves way towards downtrend or uptrend respectively. Ranging market can be identified and found before and after occurring of the uptrend and downtrend. Hence, most of the time, say around 70-75% of time, market remains in ranging mode.
There are some important points to be noted regarding trendlines :
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Longer the time frame, the more important the trendline.
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The longer a trendline is, the more is its validity.
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More the contacts between prices and trendline, the more valid the trendline is
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The angle between the horizontal axis and the trendline reflects the emotional intensity of the dominant traders.
If there is an increase in the volume when price moves in the direction of a trendline, it confirms the trendline.
If there is a decrease in the volume when price pull back to a trendline, it also confirms the trendline.
If volume increases when price returns back to a trendline, it is a warning of a potential break. If volume decreases when price pulls away from a trendline, it is a warning that trendline is in danger.
Whenever price breaks the trendline, it signifies that dominant traders have lost their power.
Trading Ruels for Trendlines :
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Trade in the direction of the slope of a trendline. Means buy when the slope is upward and vice versa.
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A trendline acts as a support or resistance level. When the price is rising, place a buy order at the uptrend line and place stop loss below that trendline. Reverse the procedure when price is declining.
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Draw a channel line parallel to the trendline to use it as target for profit making.
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A price often retests the lates extreme after breaking a steep trendline. A pullback rally to an old high on falling volume and with indicator divergences provides good opportunity to short sell.
Trendlines can also be applied to volumes. Rising volumes signifies that more people are getting involved in market and vice versa.
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