What Is a Stock Cycle?
A stock cycle is the evolution of a stock's price from an early uptrend to price high through to a downtrend and price low. Richard Wyckoff, a prominent trader and pioneer in technical analysis, developed a buy-and-sell stock cycle that occurs over four distinct stages:
How the Stock Cycle Works
Stock prices may appear random, but there are repeating price cycles, which are predominantly driven by the participation of large financial institutions. As a result, following cash flows reasoned to originate from these large players can be identified as occurring in a cyclical manner.
The Wyckoff stock cycle has expansion and contraction periods, much like the economic cycle. It can be used for portfolio management allocation, allowing for increased investment during the accumulation and markup phases and profit-taking during the distribution and markdown phases. Investors measure a stock cycle by comparing the distance between lows to help determine where prices are in the current cycle.
A trader must have a strategy to take advantage of price action as it is happening. Understanding the four phases of price will maximize returns because only one of the phases gives the investor optimum profit opportunity in the stock market. When you become aware of stock cycles and the phases of price, you will be prepared to profit consistently with less drawdown. The study of stock cycles will give investors a heads-up on trending conditions for a stock, whether sideways, up or down. This allows the investor to plan a strategy for profit that takes advantage of what the price is doing. The entire cycle can repeat, or not. It is not necessary to predict it, but it is necessary to have the right strategy when it occurs.
- The stock cycle, often attributed to technical analyst Richard Wyckoff, allows traders to identify buy, hold, and sell points in the evolution of a stock's price.
- The stock cycle is based on perceived cash flows in to and out of securities by large financial institutions.
- There are four phases of the stock cycle: accumulation; markup; distribution; and markdown.
Understanding the Wyckoff Stock Cycle Phases
- Accumulation: An uptrend starts with the accumulation phase. This is where institutional investors slowly begin acquiring large positions in a stock. Investors use support and resistance levels to find suitable entry points at this stage of the stock cycle. For instance, investors may start accumulating a security when it nears the lower end of a well established trading range.
- Markup: A breakout of the accumulation period starts the markup cycle. Trend and momentum investors make the bulk of their gains during this phase, as a stock's price continues higher. In this part of the stock cycle, traders use indicators, such as moving averages and trendlines, to help make investment decisions. For example, an investor may buy a stock if it retraces back to its 20-day moving average.
- Distribution: Institutional investors start unwinding their positions at this stage of the stock cycle. Price action begins to move sideways, as the bulls and bears fight for control. A bearish technical divergence between a stock's price and technical indicator often starts to appear in the distribution phase. For example, a stock's price may make a higher high while the relative strength index (RSI) makes a lower high.
- Markdown: Volatility often increases during this phase, as investors rush to liquidate their positions. Investors use temporary retracements to the upside as an opportunity to sell their shares, while traders look to open short positions to take advantage of falling prices. Typically, margin calls increase near the conclusion of the markdown cycle, as stock prices near their lows, which may help explain the climactic volume often associated with this part of the stock cycle. (See also: Market Cycles: The Key to Maximum Returns.)