The Three Phases Of A Bull Market
Bull Market Phases
Prior to a bull market the previous bear market knocks down prices to below “known values”. This occurs in the devastating annihilation phase which we forecast in the early portion of the last PM bear market. This forecast was met with universal derision at the time because everybody’s head was still in the previous bull market. These skeptics are no longer ridiculing this call, however they do remain skeptics. The psychological damage that they incurred by their obstinate bullishness in a bear market prevents them from embracing the current uptrend. They see this rally as simply another bear market rally (BMR) within the previous bear market.
It is with this atmosphere of skepticism that Phase I of the new bull market begins. Phase I is the Accumulation Phase, where farsighted investors sensing that prospects although now depressed, are due to turn up. They are willing to pick up all the shares offered by discouraged investors and distressed sellers. They are willing to raise their bids gradually as selling diminishes in volume. The public is disgusted with the market and has now exited. Activity has trailed off and becomes dull. Price action normally undergoes a prolonged sideways movement and becomes immune to bad news. Most remaining investors have a general disposition to expect worse things ahead, but it is now too late to sell.
It is now that stocks have sunk to below “Known Values” and under these conditions informed, serious investors begin their accumulation, therefore this phase is named the Accumulation Phase. It actually starts before the previous bear market is officially over. Competition is at a minimum as the public is disinterested, careful and controlled purchases take place as a long base is established. The uninformed public is incapable of recognizing the bargains as they don’t look for value. It is under these conditions that stocks return to Known Values. This all happens in phase I where no rule exists as to how long this process occurs. It may resemble the dynamic of a beach ball under water released or it may be a long grinding process. Either way the objective of the market is to return price to Known Values.
Phase II may be called the Mark-Up Phase. It occurs as the improved tone of business and rising price action begin to attract public and institutional attention. This second phase is the longest phase and most deceptive of the three phases. It is characterized by a steady advance building on increasing activity reflected in growing volume. It will be punctuated by secondary reactions when investors become convinced lower prices are out of the question. When the bull chorus is the loudest a secondary reaction often strikes to the downside which is unusually violent compared to the other phases.
The advancement in prices during phase II is in response to the known improvement in earnings. Stocks are marked-up because belatedly the public becomes aware that pessimism or necessity had forced prices too low. They therefore begin to buy the floating supply of stock in the market. The second phase is the only phase a skilled technical trader should actively reposition oneself by trading stocks. If one can avoid being caught in a secondary reaction then reposition oneself back in after a drop and base is formed, he can improve his position handsomely.
Phase III is termed the Blow Off Phase or Mania Phase. It is labeled this as the market undergoes a character change. No longer are stocks bought in due consideration of intrinsic value or earnings power, but instead the crowd buys on prospects only with no regard for values. Certain stocks take on a religious component as their future seems certain and the masses flock to them. The market boils with activity, financial news is all good, price advances are spectacular, IPOs dominate the financial headlines and grab everyone's attention. It’s in phase III where your obnoxious brother in law reminds you how he scored huge by flipping the latest fad stock, oblivious of course to the fact that it had been going up for years and has zero earnings. In phase III the market has been going up for so long it seems to actually take leave of its senses. General confidence has allowed price to discount not only present values, but future dream like possibilities. For those of you in the markets from 1999-2000 you know what this feels like, it’s true manic insanity, but there is no stopping it. At the market top in 2000, the bull had been roaring for 18 years and virtually all investors had never witnessed a top and were unaware of what they were seeing. Meanwhile, informed value conscious investors are engaged in quiet distribution while the public is actively accumulating. The mirror image of what occurred during the bull’s genesis. Why distribution? Because wise investors sense danger and they protect themselves by converting stocks into cash. The top is now in and the market now enters the first phase of a bear market.
The most important thing to know about phase III is that in an extended bull market a bear market signal is ONLY valid in phase III. This is why it is critically important to know how to discern what bull market phase we are in.
Separating the Phases
Secondary Reaction or Cyclical Bear
What separates the phases is a change in market psychology. It is therefore often hard to pinpoint precisely the transition from one phase to the next. The transition is often defined by a break in the price action caused by either a secondary reaction or an actual cyclical bear market within the context of a secular bull market. A secondary reaction typically lasts from 3 weeks to 3 months and it corrects 1/3 to 2/3 of the previous advance. It arrives when least expected and serves to dampen the enthusiasm of amateur speculators. It is as necessary to the stock market as a safety valve is to a steam boiler. When too many investors have climbed aboard the valve is released in the form of a intense sell off. This sell off is often mistaken as a true reversal of the primary trend, however it is not. Instead it has simply served its function of controlling the level of exuberance while a new base is constructed to support a further advance. In some cases and entire cyclical bear market lasting from 8-24 months may be required to complete the transition. These mini bears can be particularly deceptive.