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The Three Phases of a Bull Market

 -- Published: Wednesday, 5 March 2014 | Print  | Disqus 

By Brent Harmes

Have you ever wondered when to get into an investment and when to get out?

Almost every bull market has 3 distinct phases and if you can learn to recognize them it will help your odds tremendously of getting in while the market still has room to go up, and get out before you ride it back down again.

Three Phases of a Bull Market

Have you ever stood on the sidelines of an investment market (Stocks, Bonds, Precious Metals, or Real Estate) with sweaty palms not sure of what to do?

You wait and you wait while your friends brag about their returns year after year - but it just doesn't feel right. The market is so volatile and possibly near a top. Finally, as this market progresses it seems like the whole world is making money in this market, except you. You wait and wait but then decide to go for it. Finally it must be safe. So you make the plunge and enjoy several months of stellar returns but then the bottom drops out and you discover some time later that you bought near the peak of the market and it is now well on the way down.

If this has happened to you then congratulations, you took the first step and became involved in the trial and error process of investor education. Now with the second step let's see how these bull markets act as they progress and see if we can get in front of the market to be in control next time.

Bull markets typically have 3 distinct phases. With a little understanding of how a bull market "feels" and behaves as it progresses through its phases you will be able to follow along as it progresses. It will give you much more control over the timing of your investments.

In any bull market there tend to be 3 phases...

Phase 1. The "Denial Phase - "The first stage of a bull market begins just as its last bear market is ending. In fact after a true multi-year bone-jarring bear market very few people are even interested in or even watching for a bottom. As an example consider the stock market in the early 1980's, for the more than 16 years this market had gone nowhere. In 1966 the Dow Jones industrial Average hit 1,000 and in late 1982 the Dow was again at 1,000. It had zigged and zagged for these 16 years but ended up roughly where it started. For the "buy and hold" investor this period was a bust. Most had given up on this sector and were instead paying a lot of attention to the hot sectors of the day, bonds and precious metals.
Since asset classes trend up and down in long cycles with many smaller "counter-cycles" in them people who have been trying to "time the bottom" have been caught time and time again buying into the "counter-cycle" rallies. They were thinking that they had finally found the bottom of the market- only to have the bottom drop out of the market, once again, burning the investor. So, once a true bottom has formed many participants remain highly skeptical that it really is a true bottom and stay away from the market even as the market continues higher and higher.

Phase 2. The "Wall of Worry Phase" - This middle stage is where the general public becomes aware that this new market is moving higher. It is also typically the longest of the three phases. The financial and stock reporters on TV start to cover this new sector and interview the experts. To make it "fair" they find someone from each of the bull and bear camps. Each expert has a compelling argument as to why the other "expert" is wrong and why the price of this new market should go in the direction that they think it should. The investing public usually finds it difficult to take action at this point because there is so much uncertainty. They have just recently become aware that this market is moving higher, but in the back of their minds they keep remembering that not too long ago this market was going down year after year and they keep thinking of the "arguments" as to why investing in this market is risky. Examples of this phase include the stock markets in the mid-to-early 1980's and mid-to-early 1990's. Most of the public was aware that the stock market was making gains but were slow to aggressively invest in it because the pain of the past bear markets were still fresh in their minds.

The term "wall of worry" refers to the saying that "A bull market has to climb a wall of worry but a bear market slides down the slope of hope". This is an important concept to understand. We will discuss the bull market side of this saying first and then discuss the bear market side later in this article. As a bull market is advancing it doesn't feel good to the investors during this phase. The naysayers are everywhere publicly explaining away the recent advances in this market and explaining why this investment class will soon drop away. An investor that chooses to invest anyway has to decide for themselves that this is where they want to be, invest, and hang-on. Only after several years of consistent gains do the naysayers start to lighten up on their negativity and allow the participants to start feeling good about the investment they have made. When the media combines this new upbeat attitude with a chart of the gains that have happened so far then the mood shifts for the better and we enter the next stage.

Phase 3. "The Euphoria Phase" - Finally it feels good. Most of the experts that were decidedly bearish during Phase 2 have now changed their minds and are spouting the virtues of this investment class. As the media gets on board with this new idea and starts to believe in it themselves they tend to interview the few remaining "kill-joy" analysts that still think this investment is a bad idea less and less often giving the public an even more biased view that this investment is "it". Finally after all these years of searching- mankind has found the perfect investment vehicle. This is now the "must have" investment and how people get rich.

The public invests in this vehicle en masse bidding up the prices higher and higher accelerating the gains making the investment that much more exciting for everyone else that has not fully invested yet. However, when the majority of investors have joined the party then a problem starts to occur. There aren't enough new investors bidding up the price of this asset to keep the price rising as quickly-so it starts to slow down. Sometimes bull markets end with a bang sometimes they carve a long arc on the chart as they top out and start to head down. This is where the "Bear slides down the slope of hope". Keep in mind that in phase 3 most everyone is completely convinced that this investment is almost infallible. Even as the market starts down people are sure that it is just a temporary setback and stay invested, often times adding to their positions. An example of this mentality is at the end of the Dot-com bubble in March of 2000. Both individual investors and also the large investment houses were so convinced that we had indeed entered a "new paradigm" that they just could not admit to themselves that the party was over. They kept "hoping" it would come back. Many of them rode the market down, wiping out much of their wealth.

Once the market peaks it then enters the "bear market" phase which goes through its process until there are no more sellers left. Only then, when he is long forgotten, does the bull pull himself out of the ashes to once again repeat the "bull market" phases many years later.

Does this sound a little too simple? Don't believe me. Think back to every bull-market you have ever experienced. Was there a phase 1, a phase 2, and a phase 3?

If you were asked to put each of the major investments in a current category what phase do you think we are currently in for real estate? How about precious metals? The stock market?

If you really want to let this lesson soak in think about these three markets during different decades. What happened in the 1970's, 80's, 90's and so far since 2000? Do you see a pattern?
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 -- Published: Wednesday, 5 March 2014 | E-Mail  | Print  | Source:

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