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3 Phases Of Primary Trends (Part 2)
Perspective | 03 April 2009
By: Xavier Lim
Articles (51) Profile

Congratulations, if you have reaped some profit in this recent rally. Or have you missed the boat and are now waiting for prices to decline in order to get into the market and earn some quick profit? Well, we reiterate our stand that 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.

Having discussed the different bear phases in the previous issue, we shall now take a look at the 3 phases of the primary bull market.

The Dow Theory states that a primary bull market is usually characterized by 3 phases. These are the Accumulation, the Public Participant and the Excess phases.

The first phase of the primary bull market, the Accumulation period, emerges when every possible bad news has been discounted and it is usually over before all bad news is out (this marked an end of the final stage of the primary bear market). This is the stage where astute investors recognised that the market has assimilated all the bad news and business activities, although still depressed, is due to turn up. In fact, this is the stage where companies’ financial reports are in bad shape, often at their worst.

During this phase, everyone is completely frustrated with the stock market and out of it entirely, but trading activities are beginning to increase on the rallies. Astute investors pick up all the shares offered by distressed sellers and raise their bids gradually leading to selling activities diminishing in volume. This phase reminds me of Warren Buffett’s simple investment rule: ‘Be fearful when others are greedy, and be greedy when others are fearful.’

However, the Accumulation phase can be the most difficult one to spot because when the market starts to rise, there is widespread disbelief that a bull market has begun. It is during this phase that careful analysis is necessary to determine if any decline is a secondary reaction.

As the first phase comes to an end, the second phase of the primary bull market will begin. It is during this phase that negative sentiments start to dissipate as business conditions are marked by improving economic and business fundamentals. Rising trend in companies’ earnings begin to attract attention and confidence starts to mend. During this phase, most technical and trend traders start to take long positions, as the new upward primary trend has confirmed itself and is usually the longest and largest advance for a bull market. This second phase of the primary bull market is normally the best period for the technical traders to reap their largest harvest of profits as participation is broad and the trend followers begin to join in.

Finally comes the third phase of the primary bull market, the Excess phase. This is the stage where market is flocked by excessive speculation and inflation pressure has again reached an uncomfortable level. Everyone seems to be involved in the stock market, while stock valuations and confidence are extraordinarily high. It is during this phase that you will hear hawker assistants giving tips on what stocks to buy and loss-making, penny stocks are argued as companies with good growth potential. With all the speculative activities, volume continues to increase and this should be the stage where investors need to pay a lot of attention to any signs of weakness in the trend.

Although it is almost impossible to predict in advance a turning point or be able to buy at the lowest price and sell at the highest price, by understanding the different bear and bull phases, we should be able to better spot the next trend as it emerges.

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

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