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3 Phases Of Primary Trends
Perspective | 20 March 2009
By: Xavier Lim
Articles (51) Profile

It is an accepted fact that we are in a primary bear market that will go into the record books. However, due to the recent surge in the stock market, there is a strong consensus that this bear market may have bottomed out. So is it true that we have hit the bottom, or is it just ‘a dead cat rebounce’ that will give up all the gains in a matter of days? Well, let us explore further.

The Dow Theory states that a primary bear market is usually characterized by 3 phases. These are the Distribution, the Panic and the Distress phases.

According to the Dow Theory, the first phase of the primary bear market is the Distribution period, which starts in the later stages of the bull market. During this phase, majority of the investors are still in a bullish mood, after seeing companies reporting higher and continuing profits in their accounts and any negative news is being downplayed. They also look upon any decline as merely another buying opportunity, having seen the market bounce back from prior corrections.

In fact, companies’ fundamentals during this phase are still positive. However, some farsighted investors will sense that business earnings have reached an abnormal peak and it is perhaps time to unload their holdings at an increasing pace before others realize it. Although trading volume is still high, every rally tends to be lower than the preceding tops in prices and volume. While every decline is accompanied by higher volume and lower prices than the preceding bottoms, this is where majority of the investors begin to show frustration as hopes for profit fade away.

This leads to the second phase of the primary bear market – the Panic phase. During this phase, business and economic news significantly worsens and investors suddenly realize that Mr. Bear is in control. This results in buyers beginning to thin out and sellers becoming more urgent, which causes the downward movement to accelerate into an utmost vertical drop with volume surging to a climatic high. There may be a fairly long secondary recovery or sideways movement after the Panic phase, followed by the third phase will soon after. A Panic phase can last for a few weeks, a few days or even a number of times, which we have experienced in this current market situation.

Discouraged selling attributed to those investors who held on through the Panic phase or perhaps bought the stocks, which looked cheap in comparison with prices a few months earlier, leads to the final phase of the primary bear market. This is where business earnings have plunged to record lows over the preceding economic boom. During this third phase, the market moves down due to more distressed selling from those who have entirely capitulated in the stock market, but the downward movement is getting less rapid. However, better grade stocks decline more gradually because their owners cling to them to the last. The final stage of the bear market ends when every possible bad news has been discounted and it is usually over before all bad news is out.

Among all the primary bear market phases discussed by various professional investors and traders, we find that the above mentioned best describes the overall primary bear markets over past decades.

Shares Investment (Singapore) believes that the market is still within the Panic phase and is not out of it yet. Although experienced traders often take the advantage of market rallies on the secondary recovery after the Panic phase to reap some profit, retail investors should probably wait patiently for the first phase of a primary bull market to occur to prevent falling into Mr. Bear’s trap again. Next issue, we shall take a look at the 3 phases of the primary bull market.

Armed with an arsenal of investment knowledge, Xavier is the Senior Research Editor at Shares Investment.

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