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Like living organisms and
processes in nature, stockmarkets and individual companies
and their stocks go through processes of birth, growth, maturity, decline and
death or rebirth. This becomes readily apparent when one looks at the
long-term charts of stockmarkets and the long-term
charts of the stocks of many individual companies. A knowledge of these
cycles is of immense value in stock trading and investing, for if you know
what time it is on the “market clock”, either for entire markets
or individual stocks, or both, you have a pretty good idea and overview of the
big picture and are much less likely to be taken in or thrown by moves which
run counter to the larger underlying trend. This is why it is worth
pinpointing as exactly as possible where a stock is in the 4-stage cycle
described below. Note that the graphic depicts the idealized lifecycle of a
stock – birth, growth, maturity, decline and death or rebirth. In the
real world it is not always easy to determine exactly where a stock is in its
lifecycle, however, to whatever extent it is possible, it is always well worth
the effort.
PHASE 1: THE ACCUMULATION
OR BASING PHASE: the basing phase occurs
either in the early life of a new company, as it “gets its act
together” or after a period of prolonged decline in the stock price of
an established company as the company reorganises and retrenches following a
period of adverse business conditions.
This phase normally can last anything from a few months to a year or
two and may last many years. Although the stock price may be relatively
static throughout the basing phase, the technical condition of the stock is
steadily changing until, at the end of the basing phase, the stock is largely
held by owners who have no intention of selling until they realize a
substantial profit. Frequently, a well defined resistance level develops at
the top of the base area, so it is usually clear when a breakout from the
base area to enter Phase 2 has occurred.
PHASE 2: THE GROWTH PHASE: as business conditions for the company start to
improve the stock “breaks out” of its long base, on increasing
volume to enter the growth phase. The uptrend becomes self-reinforcing, as
the majority of
existing stock holders are unwilling to sell a rising asset and
new investors must bid up the price to obtain stock. The continuing rise is fuelled
by steadily improving business conditions for the company. Thoughout Phase 2 the price of the stock runs ahead of
its 200-day moving average, any approaches to which presenting buying
opportunities, and are frequently a good point at which to buy call options.
PHASE 3: THE TOP OR
DISTRIBUTION PHASE: this is the phase during
which astute stock owners, aware that the good times cannot carry on
indefinitely and that the stock is overvalued, distribute their holdings to
less discerning investors, under the cover of good economic news and rosy
earnings figures etc. There is normally plenty of time to get out, the top area usually ranges from several months to a
year or two in duration. Early warning that the good times are over and that
a top may be beginning to form is provided by the price breaking below the
200-day moving average, as it refuses to advance further and moves sideways
into the top area trading range.
PHASE 4: THE DECLINING
PHASE: a stock will normally
enter the declining phase without the reason or reasons being readily
apparent, but as the decline continues more and more bad news and evidence of
deterioration surfaces driving the price lower and lower. There are usually
one or more “false dawns” on the way down, when the market
wrongly assumes that the worst is over and that the price has bottomed, but
generally, the reverse dynamic exists to that which was in effect on the way
up in phase B: investors being unwilling to buy a falling asset. Approaches
towards the falling 200-day moving average provide shorting opportunities,
and are good times to buy put options.
On www.clivemaund our
efforts are directed towards finding and capitalising on stocks which are
late in Phase 1 or early in Phase 2, as stocks in this stage of the overall
cycle clearly offer the greatest potential for safe and substantial capital
appreciation. The reason that the Oil and Precious Metals sectors are the
focus of the website is that many stocks in these sectors are clearly in
Phase 2 uptrends. Some are midway through Phase 2 advances, while others are
early in Phase 2 or very late in Phase 1 - the ideal point at which to buy.
Most investors are news
driven, that is, they need solid fundamental evidence that the outlook for a
company is good before they buy a stock. The problem with this approach is
when they have the needed evidence, so has everybody else and it's already in
the price. I get Emails from people almost on a daily basis asking me to look
at such-and-such a stock, which has very often already risen by 400 - 600%,
and it is thus clear that the market has already discounted the good news or
outlook. The time to buy a stock is when the news is almost universally bad,
for the simple reason that this is time that nobody wants it, and the weak
hands, responding to the bad news, will be tossing it overboard, often for a
large loss. The time to sell is when the news is rosy, which is almost always
the case after a major uptrend. The public needs good news to buy, and the
financial media, who are the servants of Smart Money, are
only too willing to oblige with glowing reports and wonderful stats. The
average investor sucks it up like a vacuum cleaner, and rushes into the
market to pay top dollar, and, as in that saying "marry in haste, repent
at leisure" has plenty of time to regret it later.
Some years back there was
an election campaign slogan in the US that went "Keep it simple,
stupid!" Nowhere is this more true than in the stockmarket, where traders and investors are daily assaulted
by a tidal wave of information, both fundamental and technical, at least 99%
of which is irrelevant, and to the extent that it has the power to waste time
it is actually a handicap. You could lose a lot of sleep and easily go crazy
if you don't learn how to handle this stuff. One of the biggest challenges
facing investors, especially newbies, is learning to "sort the wheat
from the chaff" - to sift out what is relevant and significant. This is
something that takes time and experience and there are no shortcuts. Thus,
although some may consider the 4-phase cycle presented here as crude and
simplistic, it has practical application and is effective and does not
involve much time input, and that's what matters.
Some may wonder why I am
not concerned about giving away the "tricks of the trade" by
posting an article such as this on public websites, since it may encourage
more people to buy low and sell high. The answer is that there is no force on
earth, except perhaps a communist shutdown of the markets, powerful enough to
stop the average investor from buying at the top and selling at the bottom.
Nothing that has been published to date has succeeded in deflecting the
public from its insatiable desire to buy at the top and sell at the bottom,
and quite probably nothing ever will, because the masses are by definition
sheep - if they weren't they couldn't be fleeced, could they? This article
will only be read by a small percentage of those engaged in trading stocks in
these sectors, and, except for the few who have the presence of mind to save
it, or make an effort to remember the 4-phase cycle, it will soon will be
buried by layers of later contributions from other writers, and thus largely
forgotten. Only those who deserve to add the information presented here
to their arsenal of trading techniques will have this information at their
disposal in the future.
Clive Maund
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