Understanding the Four Stages of the Stock Market

Understanding the Four Stages of the Stock Market (Cycle of the Stock Market)

To achieve success in the stock market, one should be well-versed about the stages of the Stock Market and possess the technical knowledge to recognize them for timely action. Ignoring this may prove to be very costly for investors, as any wrong decision in the stock market can lead to heavy losses at an early stage. Losses in the stock market may also create another issue of committing further mistakes by entering into the wrong stocks in search of instant profits. Therefore, one must be cautious while making his part-time or full-time career in stock market.

Entering the stock market is crucial; missing the right time for entry can turn into a nightmare. A loss at the early stage in the stock market may deplete your capital and end your stock market career. I will attempt to explain the stages of the stock market using historical data from NIFTY50 (Indian Index), but it is not limited to NIFTY50. You can observe almost the same trading patterns in other global financial markets. Therefore, the logic of reading these patterns can also be applied to other financial markets worldwide (we manage historical data of major global financial markets for information and analysis of investors, traders and new entrants).

In the following section, we will highlight the stages of the stock market which is corelated with the happenings of events, as how they occur and how to read and recognize them.

The historical data of the NIFTY50, which is self-explanatory, highlights clear entry and exit points. It’s easy to observe that over a span of three years, the market experienced numerous ups and downs, with corrections exceeding 5% and gains surpassing 10%. By maintaining and analyzing such historical data, investors can identify optimal entry and exit points to minimize potential losses and maximize profits. In fact, by closely monitoring the market over a three-year period, one could identify more than six potential entry and exit points each year.

Defining Stage 1: Accumulation Period

In the historical data chart of the NIFTY50 index from 2021 to 2024, it’s clear that 2021 marked a correction stage due to the COVID-19 pandemic. At that time, the NIFTY50 index was trading at Spot 14,644.70 (the starting point). This period represents the accumulation phase, where investors and new entrants could purchase quality stocks at discounted prices, as many stocks were at or near their 52-week lows, or even below those levels.

As seen in historical stock market data over the past 10 to 20 years, it’s clear that such corrections occur every 3 to 5 years. These cycles are often triggered by global events, and during these times, news from all corners of the world tends to flood the media.

This is Stage 1. If you have the opportunity to enter the market during this stage and accumulate quality stocks with a 2-3 year horizon, you can potentially earn substantial profits as the market may turn into recovery stage soon. Imagine, if you get 3 to 5 such opportunities in your lifetime – these moments could significantly change your financial future.

Defining Stage 2: Bull Market

Following Stage-1, the market begins to recover and move upward, albeit slowly. Positive news starts to circulate globally through media reports, and investor sentiment improves. During this phase, the market will still experience some fluctuations, but these offer additional opportunities for investors to enter or accumulate more stocks. This phase is referred to as Stage-2, also known as the bull market.

In Stage 2, investors may consider both short-term and long-term buying opportunities. Booking profits during rallies, particularly when the index rises, should also be a primary strategy.

If you missed Stage-1, you can still find opportunities during Stage-2, particularly when the market experiences short-term corrections of 5-10% or you can choose individual stocks which have not moved yet. However, it’s crucial to focus on quality stocks, as the rally in weaker stocks tends to fade quickly. Patience and careful observation are key during this phase.

Defining Stage 3: Distribution Period

After Stage-2, we enter Stage-3, a phase characterized by new market highs, but with growing uncertainty and confusion among investors and traders. This stage is often referred to as the distribution period. During this time, it’s important to be cautious, instead of buying, consider selling holdings on every market high. Fresh long-term entries should be avoided, although short-term trading may still be viable with caution.

Entering the market during Stage-3 can be risky, as any downturn may quickly erase significant portions of your capital. This phase can last for an extended period, so it’s often better to remain on the side-lines, observing, and waiting for the market to correct further and stabilize.

As the market progresses through Stage-3, negative news begins to emerge, signaling a shift. Global stock markets start to decline, and once the market drops, it may not return to those levels for a long time. This marks the beginning of the downtrend and the bear market phase.

During this period, it’s crucial to avoid making new purchases. You’ll either need to wait months or even years for the market to stabilize. If you’re caught in a bear market, it could take years to recover your original capital, as stocks may continue to fall rapidly.

Defining Stage 4: Consolidation and Accumulation

After the bear market (Stage-3) is over, the market reaches a point where it has nearly bottomed out, and trading becomes more erratic and volatile. This phase is known as the consolidation or accumulation period, which can last for weeks or even months. During this time, stocks tend to reach their lowest levels. If they decline further, they often recover quickly, creating a favorable environment for long-term investors.

In Stage-4, investors should focus on a 2-3 year perspective, avoiding short-term buying and selling. The goal during this period is to invest in stocks that are bottomed out, allowing capital to grow over time rather than trying to make quick gains.

As mentioned earlier, over a 3-4 year period, investors will often see multiple opportunities to enter the market and exit with profits. These chances to buy low and sell high are visible in above historical market data. However, the key to success during this phase is patience—stock market success is ultimately a game of time and patience, and it requires a disciplined, long-term approach.

How a Bearish Trend Reversal Turns into a Correction

Typically, a bearish trend reversal continues until the index’s spot price reaches the 50-day moving average (50DMA), which generally takes about a month. However, if the reversal persists further beyond certain thresholds – such as breaking the previous low or crossing key moving averages (5DMA, 10DMA, 20DMA or 50DMA) – it can evolve into a correction phase which may last longer.

During a correction, the market sentiment weakens as both investors and traders become more cautious. Therefore, it’s important not to make fresh entries into the market until a clear “oversold” signal appears on longer-term charts, such as the yearly chart. Investors should be cautious during corrections, as market sentiment tends to be negative, and price movements can be unpredictable. However, in individual financially sound stocks one can start accumulation in small quantity.

The stages of the stock market, as defined above, can be observed in historical data spanning many years and are also evident on both daily and yearly charts.

Disclaimer

The content provided on this website is for informational purposes only and should not be construed as professional financial, investment, legal, or tax advice. The information presented on this site is based on the author’s opinions, research, and publicly available information, and is intended for general guidance. It is not a substitute for consulting with a qualified financial advisor or other professional.