How Stock Market Works? 4 Different Stages Of Stock Market

August 5, 2019 | Investopaper

Almost all of us are well known with the statement by Heraclitus, a Greek philosopher, “change is the only thing constant in this world.” And the stock market is the market which undergoes through regular change. And they follow a certain cycle of change. Understanding the movements in the stock market helps the trader identify the trading opportunities and helps them make a decision for maximization of profit and lowering of the risk.

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The fluctuation of stock market prices is often difficult to be tracked and followed. The stock price on one can be rising and another can be falling at the same point of time. This can seem confusing to an average person.

Besides, the stock market cycles clearly undergo similar ways and repeatedly follow the same phases in the market. Once an investor gains the idea of the sequence of occurrence of phases, the markets will seem to be managed accordingly. The investor will then recognize each phase and adopt the way of trading. Mainly, the stock market goes through four phases in the stock market cycle, which can be learned below.

1. THE COLLECTION OR ACCUMULATION PHASE

The accumulation phase can be applicable to an individual stock or the market as a whole. There does not exist any clear trend, and the stock usually trades in a range. It is that span of time where traders and institutions are slowly accumulating shares. The accumulation phase is also known as basing period in the stock market because this phase comes after a downward trend but precedes an uptrend.

At this phase, the traders accumulate their shares before the market breaks out. The moving average does not provide a clear indicator at this point as the market is not following a particular trend. The longer the accumulation phase, the stronger will be the break out in the market when the stocks start to trend.

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The timeline of the accumulation phase may last a few weeks or a few months. So, the traders require to use this time in studying the market and anticipate the right time to enter. In this phase, the price range is small and not particularly advantageous for day traders. It is advisable not to make large trades at this time until a market trend is established. The events occurring in the economy can take stock out of this phase as an uptrend begins. Once this accumulation phase is broken, traders begin to face highs and lows in the market as the cycle moves to the run-up phase in the market.

2. THE COMEBACK OR RUN-UP PHASE

This phase consists of a strong and up-trending market. This is a great period for momentum traders. Trend brings thrust and volume in the market, which means there is a chance of making a lot of money. After the accumulation phase, a whole new set of buyers enters the market. The market will face a higher relative volume during the early stages of this period as the market begins an uptrend.

There is an increase in demand for a limited supply of an asset during this period. As a result, the price of an asset begins to appreciate in value. Moving averages start to slope upwards, the key resistance levels of market breaks, and there will be a consistent set of higher highs and higher lows on the chart. Short sellers rush to cover to avoid getting squeezed, and breakout buyer rush to buy before the price increases. There will be optimistic sentiments around the market.

The accumulation phase is defined by its resistance to the changes in stock prices whereas the run-up phase is defined by the price going above this resistance level. This is the best time for a trader to make money. There is an upward movement of prices which is an opportunity for traders. Any downward trend during this period is not viewed as a bad thing but rather an opportunity to buy shares. The run-up phase is best for swing or short-term traders. As this phase progresses, the volatility in the market decreases as prices move slowly every day.

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 3.  THE SCATTERING PHASE

The scattering or distribution phase is also known as the reversal stage where traders who purchased stocks during the accumulation phase begin to exit the market. There is an increase in the volume of shares but not in its price. The market is usually bullish in nature but the demand does not exceed the supply of shares enough for the prices to increase. The distribution phase is identified through certain chart patterns like the head-and-shoulders top or bottom top. As the phase progresses the market starts to lose its volatility as a range begins to form. This phase is not favorable for the traders.

4. THE DIMINISHING OR RUN-DOWN PHASE

The final phase of the stock market is a decline or run-down phase which is not a favorable time for most investors. Those traders who bought stocks during the distribution phase try to sell them. There exist a few buyers who meet the sale of shares. There is a lack of demand which ultimately causes the prices of stocks to decrease. When the market faces higher lows in the market for a long period of time, it indicates that the market is heading towards the accumulation phase. In this phase prices of stocks fall lower than expected. The trader should not panic and sell during this period because this phase does not stay for forever. It is followed by the accumulation phase and the cycle continues.

TAKEAWAY

The takeaway from the article is to understand how different stages of stock market works. This will help you prepare different strategies during these stages. Moreover, if you want to benefit from the changing market trends, then it is very essential to know how the market operates. The ups and downs of the stock market are not avoidable. So, it is better you learn to cope with those changing situations.  Also, learning about different cycles will help you to remain emotionally stable and calm. As a result, you will be able to make wise investment decisions.

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