Market Cycles and Trends—Section 11
Although there are hundreds of stock, bond, option, futures, commodity, and currency markets throughout the world we will concentrate on the U.S. stock market. The U.S. stock market, like most markets, is cyclical in nature, moving from bull market highs to bear market lows and back again.
These cycles are made up of a series of trends. A market trend can be defined as the propensity for the majority of market components to move either higher or lower at approximately the same time. This means that most stocks move up or down together as a group.
The stock market moves in trend because investors receive the same economic information at approximately the same time. If the majority views the economic data favorably, they are more likely to buy then sell and the market will move up. If the majority views the economic news unfavorably, they are more likely to sell then to buy and the market will decline. Occasionally the economic data will be contradictory and no general consensus about future economic activity can be reached. In this situation the market may drift sideways for a while. Eventually, however, as economic information continues to accumulate, the market will resume its trending behavior.
Market trends range from a few minutes to several decades. The longest trend is the Secular trend which can last for 20 years or more. This is followed by the Primary Trend which typically lasts for several years.
There are also Intermediate Trends lasting weeks to months and Minor Trends lasting for days or weeks. Intraday Trends last for a few minutes to a few hours. All of these trends occur simultaneously and can be contradictory. The Primary Trend can be up while the Intermediate Trend is down, as would occur during a bull market correction or the Primary Trend can be down and the Intermediate Trend up, as during a bear market rally (see section 12).
There are many techniques for estimating the direction of the short intermediate and long term market trends, none of which are accurate all of the time. The best that you can hope for is to be on the right side of the important trends most of the time.
We will concentrate on the Primary Trend which usually defines a bull or a bear market. The easiest way of identifying the direction of the primary trend is by looking at the major market indexes, the most popular of which are the Dow Jones Industrial Average, the Standard and Poor’s 500 Index and the NASDAQ Composite Index. Of the three, it has been my experience that the S&P 500 Index is most representative of the U.S. stock market as a whole.
The S&P 500 is made up of 500 very large U.S. corporations whose combined worth represents about 80% of the value of all stocks listed on the New York Stock Exchange. When the S&P 500 is moving up, usually the majority of the U.S. stocks are also moving up. When the S&P 500 is moving down, the opposite applies.
Quiz Section 11
1. The stock market moves in trends because:
A) It is fun to do what everyone else does
B) Investors receive economic data at the same time and often come to similar investment decisions.
2. A bull or bear market is defined by which type of trend:
A) Intraday
B) Secular
C) Intermediate
D) Primary
3. What is the most important trend for mutual fund investors?
A) Minor Trend
B) Intermediate Trend
C) Primary Trend
4. Is there any way to be certain about the direction of market trends?
A) Yes
B) No
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