The gyrations in daily stock market prices are due to the greed and fear of investors. This is also called the tides of speculation. Before we begin the discussion on the topic, it is best you try to look at the above chart to understand what constitute a market cycle.
Keep cool while others lose theirs
Whenever there is euphoria over a particular stock investors will be pouring over the stock in order to have a bit of the action. When fear hits, they will be rushing out in panic like someone yelling ‘fire’ in a packed cinema. So one of the pillar of success in investing in the markets is keeping your head while others are about to lose theirs.
Understanding where we are in a stock market cycle is one of the most important information that we need to know for successful speculation. Even if you have insider information of a certain stock which have good fundamentals will not do any good to the stock prices, if it is trading in the euphoria phase. Chances of it coming down is much higher as it is already on its last leg of the run.
Know the Stock Level
The problem is most people don’t know where the stock is coming ‘in from’. That means they buy the stock either through tips, broker recommendations, chasing the stock or any other reasons other than ‘what level it is trading at before’.
As you know there are only three ways a stock can move and they are up, down and sideways. So without understanding at what level the market is trending, it makes it very difficult to make money.
Ways to recognize market conditions
The problem is how do we recognize the ‘level’ where the market is now trending? Fortunately, there are several ways that helps us to determine the market condition.
One, is the failure of stocks to respond to good news. During a bull run, the market will react favorably to any piece of news as long as it is good. News like declaring dividend, better than expected results, Merger and Acquisition, signing of a large contract, discovery of a large mineral deposit and etc, will tend to push up the stock prices. Investors should take note whenever such announcements are made and the market does not respond, it means that serious trouble lies ahead. This is because such news are already factored into the market and the market had already run out of steam. What’s next? Expect sharp reversal of the market to follow.
Two, it is exactly the opposite of the first symptom. During the bull run, whenever there are bad news announced, stocks are still advancing. This happens because stock promoters and market makers are doing their best to support stock prices so that they can distribute as much stocks they can before the impending fall. Individual investors usually had their minds blurred by the market euphoria, failed to recognize such conditions. They are only able to see rosy things and advancing prices and volumes. Failure to anticipate such events will result in big losses when the market turns.
Three, another pattern that need to be identified is the volume build up without the commensurate advancing in stock prices. Such conditions represent what we called ‘distribution’ by informed investors. Informed investors with advanced knowledge of the market conditions will start unloading. However to an uninformed investor, a build up of volume is a good indication that better things are ahead.
In order to recognize the distribution of stocks, we need to study the high, low and volume traded of leading issues. If the leading issues are trading at the same or lower price than yesterday’s closing but with a much higher volume then we can conclude that someone is unloading the stocks. Then we can anticipate a downturn in the leading issues in the next few days.
Four, if the volume of the overall market is trading at record levels then investors need to
Be careful. Normally under such conditions, it represents the euphoria stage (see chart above) and this is where every mother’s sons and daughters will be talking about stocks. There will be a lot of experts offering advise and stock market will be the leading topic of choice be it during cocktail parties or wet market gatherings. Nevertheless, the print media will be doing its utmost assistance to the investing public by publishing news on the market day in day out. To an informed investor, it’s game over and time to leave the party.
So, when you are able to distinguish between the beginning, intermediate and the end of a market run will greatly help you in your stock market speculating endeavor.