Why Stock Market Cycles Indicate the Need for Caution

Stock Market Cycles: Understanding the Three Stages of the Market

Updated Aug 26, 2024

As an investor, it’s crucial to understand that the market doesn’t have just two stages – buying and selling. The “sit and wait” stage is a time to hold off on buying or selling and wait for a correction. When the market or specific sectors pull back, the correction tends to be severe, with sectors shedding 50% or more of their value.

The key is to wait for technical indicators to signal a strong buy before making any moves. If technical indicators pull back to oversold ranges, the trend indicator remains positive, and bullish sentiment drops, it’s time to back the truck up and buy. Understanding these three stages of the market and taking a patient

Navigating the Sit-and-Wait Stage for Investors

The sit-and-wait stage is a crucial part of stock market cycles, as it breaks the average investor, especially those who assume their degrees or high IQ give them an edge in the markets. The acronym PhD stands for Doctor of Philosophy, but we have a better acronym at the Tactical Investor: permanent head damage. Most Ph. Ds suffer from that, especially those originating from economics.

The only things that help with stock market cycles are having an open mind and understanding mass psychology’s basic principles. Technical analysis provides the ability to fine-tune entry points. Astute investors know that the most critical stage in the market is the sit-and-wait stage, otherwise known as the Patience and discipline stage.

Overtrading leads to mediocre gains or losses, but more importantly, the stress factor surges by 4X, if not more. Factoring in the extra stress and the damage it causes to one’s health nullifies any of these gains. Astute investors view health as their number one investment; everything else comes in at a very distant second.

The Importance of Health in Stock Market Cycles: Making Gains with Patience and Discipline

Does it matter if you make money in the first four months or the last three months of the year? Those who understand this simple principle can generate 20% a year with minimal effort, little stress, and significantly more with a bit of work. Ultimately, health is the ultimate investment, and you lose your health. Even if you have a billion dollars, you are worse off than a beggar in good health. On the other hand, if you have optimum health and just 50k to 100k, you can turn that into a small fortune, but you are off to a good start as you still have your health.

The markets experience a correction almost every year. In most instances, when the bullish sentiment soars past the 55 park several times over 60 days, the market almost always lets out a decent dose of steam. Any subscriber with us for 12 months or more knows that Tactical Investors never chase the market or a given stock. We let the market come to us; that is the only way to score massive wins; case in point, the COVID crash.

Patience and discipline: Key traits to winning the game

In the trading world, many investors tend to lack patience and discipline. Instead, they rely on fear and euphoria to guide their trading decisions, often leading to mediocre gains or significant losses. However, the key to successful trading is a systematic approach involving patience and discipline.

No change in the Anxiety index and there is a spike in the number of individuals in the neutral camp. This informs that many traders don’t know what to do or expect from the markets, which is bloody good news. When the markets sell off the dumb money will be doing most of the selling while the smart money will be waiting for the fear levels to surge, and then they will come in and start buying. Market Update Dec 31, 2020

At Tactical Investors, our trading methodology focuses extensively on these creeds. We never chase the market or a given stock. Instead, we let the market come to us, waiting for times of uncertainty to buy and banking profits during times of certainty. This approach is grounded in understanding stock market cycles, which indicate that markets climb a wall of worry and plunge down a cliff of joy.

The Importance of a Rational, Data-Driven Approach

A rational, data-driven approach is essential for navigating market cycles and making sound investment decisions. Emotional decision-making, driven by fear or greed, often leads to poor outcomes. Investors can make more informed choices by focusing on data, reducing the influence of cognitive biases and mass psychology.

Jesse Livermore, one of the most famous traders of the early 20th century, is a prime example of someone who emphasized a data-driven approach. Livermore believed in the power of technical analysis and market trends to guide his trading decisions. He famously said, “Markets are never wrong; opinions often are.” Livermore’s approach was grounded in the belief that market prices reflect all available information and that careful analysis of price movements could reveal profit opportunities.

For instance, during the 1929 stock market crash, Livermore used his understanding of market cycles and technical signals to predict the downturn. While many investors were caught off guard, Livermore shorted the market, making a fortune when the crash occurred. His success demonstrated the power of a rational, data-driven approach in anticipating market movements and capitalizing on them.

Combining Technical Analysis with Behavioral Psychology

Combining technical analysis and behavioural psychology can create a powerful strategy for navigating market cycles. Technical analysis, which involves studying price charts and market patterns, provides a framework for understanding market trends. When combined with behavioural psychology insights, which examine how emotions and cognitive biases influence investor behaviour, this approach can offer a more comprehensive view of the market.

For example, during the accumulation phase of a market cycle, the technical analysis might reveal bullish patterns, such as higher lows and increasing volume, signalling that smart money is entering the market. At the same time, behavioural psychology can help explain why many investors remain pessimistic, possibly due to recency bias from a recent downturn. Understanding this disconnect between market sentiment and actual market movements can create opportunities for contrarian investors to buy undervalued assets before the broader market catches on.

Conversely, during the distribution phase, technical analysis might show bearish divergence signals, where the price continues to rise, but momentum indicators, like the Relative Strength Index (RSI), start to decline. This can indicate that the market is overextended and smart money is beginning to exit. Behavioural psychology can also play a role here, as the herd mentality may lead inexperienced investors to continue buying, driven by fear of missing out (FOMO). Recognizing these signals can help investors avoid the pitfalls of buying at the top of the market.

Looking Ahead: Embracing the Inevitable

The future will undoubtedly bring new market cycles, with periods of exuberance followed by downturns. Investors who embrace this inevitability, understanding that every cycle presents risks and opportunities, will be better positioned to navigate the market’s ups and downs. By staying informed, remaining disciplined, and continually refining their approach, investors can survive and thrive in the ever-changing landscape of the financial markets.

Ultimately, the key to long-term success lies in adapting and evolving, learning from past experiences while staying open to new ideas and strategies. As the saying goes, “The only constant in life is change,” and nowhere is this more valid than investing. By understanding market cycles and the psychology that drives them, investors can turn this constant change to their advantage, building wealth and achieving financial security for the future.

In conclusion, certainty about the stock market cycles is probably the best signal that you will get hammered. Therefore, it is essential to have an open mind, check ten times before getting into something, and understand the basic principles of mass psychology to fine-tune your entry points. Moreover, astute investors view health as their first investment, knowing that overtrading and stress can nullify any gains.

You buy during times of uncertainty and bank profits during times of certainty. Markets never climb a wall of joy; they climb a wall of worry and plunge a cliff of Joy. Sol Palha