psychology

Psychology of market cycles

Daksh Murkute | | |

Just within the last couple of years, we have seen the markets move in cycles that would otherwise take almost a decade from beginning to end.

 

But, what are these market cycles and why does it happen? Are these market cycles good or bad and how exactly should traders and investors participate in the markets during each cycle? You’ll find all answers in this blog post.

 

To begin with this blog post, I will first tell you about the different types of market cycles using a very famous theory formulated by a renowned trader.

 

I will then break down each and every market cycle for you and you’ll understand exactly what happens during these cycles, what the sentiment is, and how exactly you should act during these cycles. So stick around till the end.

Contents

 

 

What are market cycles?

 

What are market cycles?

 

Back in the early 20th century, when there were great minds trading in the financial markets, there was one man that went by the name Richard Wykoff, who wrote about the markets.

 

Richard wrote about the phenomena in which the prices move in a pattern, or rather a cycle, and this observation that Richard made, works to date.

 

I guess Richard was the first one to formally write about these market cycles that he observed and then subsequently people started observing things and also wrote about them.

 

So in a nutshell, the market cycles that Richard and other people wrote about, basically speak about the pattern in which the price of literally any financial asset tends to move in.

 

I will simplify things a little bit for you and you need to know that there are mainly 3 cycles that the price moves in and these are uptrend, downtrend, and sideways.

 

You may also know this as accumulation, distribution, consolidation, and whatnot. But all terms mean the same and I just wanted to make it simple for you to understand.

 

Now, an uptrend is when the price is moving in the upward direction and we see the price increasing over time.

 

On the other hand, a downtrend is when the price is moving in a downward direction and the price of the financial asset keeps decreasing.

 

The third market cycle is one when the price of the financial asset isn’t really moving up or down definitely but is rather moving sideways. So in such a cycle, the price doesn’t change much and even if it does, then it will be a minor change in either direction.

 

 

Why do the markets move in cycles?

 

Why do the markets move in cycles?

 

Now, I believe that you are very well clear about the different cycles that the price moves in and now it’s time to know the reason behind such price movements.

 

To understand this you first need to understand that the financial markets move on the basis of two simple things, demand and supply, and market sentiment.

 

We could very much say that demand and supply happen because of market sentiment but we’ll just go ahead with it.

 

Now, what is the price of a financial asset? How is it derived? The answer is that it is derived from the consensus between the buyer and seller whenever they agree to buy and sell the financial asset respectively.

 

At any point in time, the buyer would feel that the price is cheap enough to buy, or at times the seller would feel that the price is too expensive and they would want to sell.

 

It is because of this very simple activity that we see the prices of literally every financial asset in each and every financial market move the way it does.

 

This was just an overview of the entire market cycle. Now I’ll break down each and every cycle and I’ll tell you the reason why a particular cycle happens.

 

 

Psychology behind the market cycles

Just a recap, there are 3 cycles that the prices move in and these are uptrend, downtrend, and sideways.

 

Now, the reason why each cycle happens is because of demand and supply and market sentiment. But the market sentiment during each cycle is very different.

 

The view that traders or investors hold during each cycle would differ and this is primarily what makes the price move in the way it does.

 

1. Psychology during an uptrend cycle

 

Psychology during an uptrend cycle

 

Do you remember the crypto bull run that happened last year and we’d see the price of literally every crypto listed on the exchanges just go to the moon.

 

By the way, I do have another venture that goes by the name Cryptos Monopoly. I have a website as well as a YouTube channel that goes by that name. You can check it out if you want to.

 

Getting back to the point, so during the crypto bull run, the mood of the market was very different and if you were active during those times, then you would have observed it too.

 

The buyers of the cryptos believed in the idea of the industry, i.e. the crypto industry and everyone held the view that crypto is the next big thing and the prices of all cryptos will increase multi-folds in the future.

 

Now, you should notice that the market sentiment here was that of thrill, optimism, and euphoria.

 

This wasn’t just the case with the crypto bull run but in fact, if you observe all the bull runs that we have had in the financial markets in the past, then you’ll observe the same type of market sentiment.

 

So what really happens during such times is that people become very optimistic about the prices and they start feeling that the price of a particular financial asset will increase for sure and they start buying that asset.

 

Maybe some fundamental changes took place that made people become overly bullish or something else might have happened that acted as a catalyst.

 

But when initially the market participants see the value and they start entering, the price doesn’t really rally upwards much. The price skyrockets when other people on the sidelines see it and they start following the herd and just get into a buying frenzy.

 

Just when the remaining flock of market participants starts jumping in, that’s when we start seeing the price blast off in the upward direction and we get a full-blown bull run.

 

But, will such bullish runs last forever? Will the price of the financial asset keep moving up all the time? No right. There will come times when the buying frenzy stops and the price will start moving in another cycle.

 

 

2. Psychology during a sideways cycle

 

Psychology during a sideways cycle

 

A sideways market cycle, as the literally suggests, is when the price is moving sideways and you can actually draw a channel or a range that the price is stuck within.

 

I am taking up this market cycle after the uptrend cycle just as an example and it won’t always happen that an uptrend is followed by a sideways cycle.

 

Now, if you want to know an example of a sideways market cycle then open up the chart of financial assets after the '90s crash when everything had settled.

 

You’ll see that after such a tumultuous event, there isn’t much strength left in the price to actually start moving in either direction as such, at least not right after the event.

 

This type of cycle or this period would indicate uncertainty, caution, and even low confidence among the market participants.

 

Why is the price not moving up or down? It is obvious right, it’s because the market participants aren’t really aggressively buying or selling.

 

Why aren’t they aggressively buying or selling? Again it is obvious, it is because they don’t really know whether the price is cheap enough to buy or expensive enough to be sold.

 

It is during these times that the market participants are waiting for some event to happen that would give them a sense of direction as to where the price could move in.

 

Another characteristic of this market cycle is that it acts as a cool-off period after a huge uptrend or a downtrend where there was intense buying or selling happening.

 

Now, this sideways cycle could be 2 things, it could either be a brief moment before a complete price reversal, or it could also be exhaustion that is followed by a continuation into the prevalent trend.

 

We cannot really predict for sure what will happen after this type of market cycle and all that we can do is wait for a market signal and then only act accordingly.

 

Also Read: The Elite Trading Mindset

Also Read: Emotional Trading

 

 

3. Psychology during a downtrend cycle

 

Psychology during a downtrend cycle

 

We have seen why the price moves in the uptrend cycle and also, why it moves in the sideways cycle. What’s left is the downtrend cycle.

 

If you were active in the financial markets during early 2020 just when the news of the perils of the pandemic broke out, you would have seen how chaotic the financial market became.

 

Every day we woke up, we’d see news flashes everywhere of prices of financial assets just crashing below unprecedented levels and it was actually chaotic.

 

This is the best example that I can give you of the downtrend cycle. Another example would be that of the 2008 market crash during which the prices tanked too.

 

This market cycle is a clear indication of pessimism, fear, and panic among market participants due to which they just end up selling everything and selling it all quickly.

 

As you would have seen during the corona market crash, people were just so pessimistic about everything, and all of that got channeled into the financial markets and prices dropped big time.

 

All it takes is one small spark and it can grow into something so big and create turmoil everywhere.

 

With this downtrend cycle too, the thing of herd following plays out too, just like I had mentioned in the part where I told you about the psychology during the uptrend cycle.

 

Once the selling begins other market participants start getting into it like they’re following the herd and then we see the price keep crashing all the way down.

 

It is also often said that when the markets go down, they go down very fast and it goes down faster than when the market would go up. This is all because of the fear among the market participants and during the downtrend cycle, the volatility is the highest.

 

But again, this type of market cycle will not always keep going on. You can see it with the pandemic market crash too. After the bear run, the market seemed to have recovered after it.

 

After such a downtrend market cycle, the price would then get into the sideways cycle or even the uptrend cycle. Nothing is certain though.

 

 

How you should act during each cycle?

 

How you should act during each cycle?

 

I have extensively told you about the psychology behind each market cycle and I believe that you now have a great understanding of it.

 

But I am sure that you might have a question lingering in your mind as to, how should you act during each market cycle and I’ll get into that part of the blog post now.

 

To know this, you should first know what type of market participant are you? Are you an investor or a trader? I want you to know this because the way an investor would approach the market cycles would be different than how a trader would react to them.

 

I will first talk about how an investor would act during each market cycle.

 

I’m sure you would have heard this saying, “Buy when others are selling and do nothing when others are buying.”

 

What this really means is that, if you are an investor, you should be accumulating or buying when others are selling, this is when there is a downtrend.

 

The main logic here would be that when everyone is selling, you as an investor are getting the price at cheap, and you can buy it now hoping that it will increase in the future.

 

And on the other hand, when there is already an uptrend going on, if you already haven’t entered it, you should just stay away as you never know when the uptrend would finish and when the downtrend begins.

 

Also, when the price is in the sideways cycle, you as an investor should try and understand if it is a consolidation before a reversal or a continuation.

 

Once you get this right, you may just put yourself in a position to ride out an entire trend.

 

Now, what if you are a trader, how should you be trading in such different market cycles?

 

Well, it depends on the type of strategy you trade. If you are a trend-following trader, then both the uptrend cycle and the downtrend cycle will be great for you.

 

On the other hand, if you trade with a strategy that makes you capitalize on price consolidation then you’ll do great during the sideways cycle.

 

You need to trade to your strengths and according to your strategy. If the market conditions aren’t favorable to your strategy, then it would be best if you just sat on the sidelines and waited.

 

 

What do you think?

Do let me know what you think about everything I’ve told you about in this blog post and do you have anything else to add to it.

 

Do share this blog post with others and let them also know why exactly the market moves in cycles and how they should act during each cycle.

 

You can always reach out to me for anything and I’ll make sure to get back to your whenever I can.

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