During the previous week we saw how the vast majority of investment markets enjoyed an upward movement boosted by the positive data from the United States CPI. This fact has encouraged investors and according to market consensus, the Fed could begin to soften rate increases, interpreting it as a possible end to the downward trend that we are experiencing throughout 2022. But let's not trust ourselves, it is not Of course this bearish trend has ended. Let's see in today's investment training what market cycles are to analyze the current situation and predict if this downward trend has really ended.
What are market cycles?
Let's start this investment training by defining what market cycles are. These cycles are trends or patterns that can occur in a given market environment. These market cycles are difficult to define until they have happened and they do not usually clearly offer their beginning and end. Although in the consensus of investors, these cycles can be taken advantage of by trying to identify the moments in which turns occur that lead to a change in the cycle. Turns or changes in cycles can be detected through a series of patterns that repeat over time, allowing us to develop scenarios predicting future market movements. We can identify these turns both with macroeconomic indicators (we explained them to you in another investment training article a few weeks ago) and with technical indicators (the ones we teach you in the trading training articles). Additionally, Dow theory tells us that there are different market cycles, which we can categorize according to their duration. Therefore, we can distinguish market cycles of short, medium and long duration, where smaller cycles can be part of a larger cycle.
How long does each market cycle last?⏱️
This is a somewhat abstract question, given that market cycles can have different durations depending on the market and the time horizon we are analyzing. These cycles can range from a couple of weeks to quite a few years. That does not mean that we cannot classify cycles according to their duration:
Short duration cycles.
These cycles usually last approximately 40 months, which are also known as small cycles or Kitchin cycles (not to be confused with chaikin, the last technical indicator that we show you).
Medium-length cycles.
These cycles usually last approximately between 7 and 11 years. These cycles are a series of short cycles that do not come to an end and evoke economic crises. They are also known as Minstrel cycles.
Long duration cycles.
These are the cycles that have the longest lifespan, persisting for an average of 46 to 60 years. In these cycles (called Kondratieff cycles), we can see that the phases that compose them are soft and develop slowly.
What are the different market cycles?
Regardless of the asset market we are analyzing, market cycles are defined in four phases that have similar characteristics between them. Among them, it can be determined that all markets see cyclical patterns that evoke increases, the achievement of maximums and then a fall. Let's see then the 4 types of phases of a market cycle:
Accumulation phase.
Accumulation comes from periods of pessimism in the market, usually accompanied by bad news and market forecasts. Institutionals sell to attract sales while buying massively to stop the fall. In this phase the market sentiment remains bearish and those who maintain their losing positions end up liquidating their positions during this phase, assuming the losses. The market price trend begins to change from bearish to neutral.
Upward trend.
In this phase the market has prevailed in a period of stable consolidation during the accumulation phase. It is the moment where increases in prices begin to be seen, which is understood as the beginning of an upward trend. It can be seen that the minimums are successively higher, where more and more investors join the trend. This phase is when euphoria enters the market, producing large increases in the price in the short term. From there, we can see the climax of the uptrend, where experienced investors begin to close positions and less experienced investors begin to ride the trend. At this moment, we can see how the price increases are starting to become smaller.
Distribution phase.
This is when you begin to observe that the bullish trend begins to sideways, where the price is established within ranges that we can easily define. In this phase is when we can observe chart figures trend reversal, such as a double or triple top or a HCH (shoulder-head-shoulder). In this phase is when we can see that new highs are formed on different occasions, each time closer together and with lower volume. From this moment on, professional investors stay out of the market, where market sentiment goes from neutral to negative, usually boosted by bad news.
Downward trend.
The last phase of a cycle is where the selling pressure in the market begins to grow strongly. We can see how little by little the achievement of decreasing maximums is being observed, where less experienced investors maintain their losing positions in the hope of being able to take advantage of an upward movement that will allow them to exit the market without losses. This is preceded by the institutional distribution campaign, where little by little they establish sell orders to push the price down. This causes stock market panic in less experienced investors, favoring selling pressure that sinks market prices.
Example of market cycle analysis in an asset.
To put the analysis of market cycles in context, let's take Bitcoin as an example. The market cycles that it has experienced during a defined period that allows us to clearly see how to differentiate the different market cycles in an asset.
After the ban on mining in China, we saw how the price of Bitcoin fell sharply, where investors began to lose hope in the cryptocurrency ecosystem. During the summer of 2021 we saw an accumulation period that allowed less experienced investors who bought at the previous ATH to sell their positions at a loss and more experienced investors to start accumulating at lower ranges. Next, we saw how the price of Bitcoin began to slowly recover, witnessing an upward trend that evoked the achievement of new all-time highs. Next, the euphoria within the cryptocurrency ecosystem suggested that we could aim to reach figures like $100.000. But the achievement of two maximums so close together began to set off the alarms, where we were already in the distribution phase. In this phase, experienced investors had already sold their positions and less experienced investors entered the market due to inexperience and fear of missing out on greater increases. Finally, with the correlation that Bitcoin had with the American indices, the beginning of the escalation of tension between Ukraine and Russia took the price of Bitcoin to hell. Clearly we were already in a bearish trend, where the achievement of decreasing highs can be clearly seen.
Conclusions from this training in investment on market cycles.
As we have seen throughout this investment training, market cycles must be taken into account to be able to operate in the financial markets, regardless of the type of asset they are. Each market can develop its movements based on a series of guidelines or factors that affect the price of said assets, but market cycles move in the same way for all markets.
In turn, we have learned that these cycles can have specific durations, which can be part of each other. Additionally, each market cycle is linked to a series of feelings that the investor can perceive as the cycles develop, as you can see in the graph above. These feelings are linked to each cycle, and can determine the cycle in which a specific market or asset is located.