What Are Market Cycles And How Can You Use Them?

FXOpen

Market cycles are a cornerstone of financial trading, shaping the opportunities and risks faced by traders across various markets. This article delves into the key phases of market cycles, how they manifest in different trading arenas, and how traders can capitalise on these predictable patterns for trading success.

The Four Phases of Market Cycles

Market cycles typically consist of four main phases: Accumulation, Markup, Distribution, and Markdown. Understanding these phases is integral for traders looking to maximise gains and minimise losses across all kinds of markets.

Accumulation

This is the first phase where savvy investors start buying, often when the market is flat or bearish. Prices are at a low, and there's little interest from the general public. Trading volumes may be lower during this period, making it an opportune time for informed traders to accumulate assets.

Markup

Following accumulation, prices start to rise. This phase is marked by growing investor confidence and increased media attention. It's during the markup phase that the majority of traders enter the market, lured by signs of a bull market. Technical indicators such as moving averages and RSI often show upward trends. In the market cycles chart above, we can see the crossover between a 21-period and 50-period Exponential Moving Average (EMA) lining, pointing to bullishness as the markup begins.

Distribution

After the markup phase peaks, we enter distribution. In this stage, those who accumulated assets early begin to sell, taking their profits off the table. This phase often has periods of sideways price movement and can be difficult to distinguish from a continued markup phase. However, trading volumes usually increase as both buying and selling activity rise.

Markdown

Finally, there's the markdown phase. In this stage, prices drop, often rapidly. General investors, late to exit, incur losses. This decline continues until assets are considered undervalued, setting the stage for another accumulation phase.

Market Cycles Across Different Markets

Understanding market cycles isn't limited to one type of market. Let's delve into how market cycles manifest in different arenas like stock, forex, commodity, and cryptocurrency* markets.

Stock Market Cycles

The stock market perhaps shows the clearest cycles, mainly due to its long history and extensive data for analysis. Stock market cycles often correlate with economic conditions, and they can span months to several years. Accumulation phases often occur during recessions, followed by markup phases during economic expansion. Distribution and markdown stages might coincide with economic slowdowns or contractions.

Forex Market Cycles

Currencies trade in pairs in the forex market, making their cycles somewhat different. Currency pairs are influenced by global economic indicators and events, from GDP growth to interest rate changes. Cycles here are often shorter, sometimes only lasting a few weeks or months, making rapid strategy adjustments crucial.

Commodity Cycles

Commodities like gold, oil, and agricultural products have their own cycles, often tied to supply and demand fundamentals. For instance, oil prices may rise during geopolitical tensions (markup) and fall when new supply routes open (markdown).

Crypto* Market Cycles

The crypto* market is relatively new but has exhibited distinct cycles, mainly due to its 24/7 trading environment and high volatility. Accumulation often occurs after a significant price drop when the general sentiment is negative. Markup phases can be exceedingly rapid, sometimes only lasting weeks or even days, followed by equally swift distribution and markdown phases.

Driving Forces Behind Market Cycles

Market cycles are influenced by a combination of economic and psychological factors that shape the behaviour of traders and investors. Identifying these driving forces can provide valuable insights for market participants.

Economic Factors

Fundamental economic indicators such as GDP growth, interest rates, and inflation often serve as catalysts for market cycles. For example, low interest rates might kickstart an accumulation phase as borrowing costs are low, and investment opportunities look more appealing. Similarly, a hike in interest rates may signal a distribution or markdown phase as investors seek to exit riskier assets.

Psychological Factors

Market sentiment plays a crucial role in the cyclical behaviour of financial markets. Ideas like the stock market’s 7-year cycles, although not empirically proven, can influence investor psychology. This concept suggests that financial crises occur roughly every seven years, contributing to a sense of impending doom as a cycle reaches this time frame. Such psychological factors can sometimes be self-fulfilling prophecies, leading traders to make decisions based on perception rather than underlying economic conditions.

How Traders Use Market Cycles to Their Advantage

Traders leverage their understanding of market cycles to formulate strategies that capitalise on each phase's unique characteristics. Here are some ways traders use market cycles to their advantage:

Long Positions in Accumulation Phase

During the accumulation phase, informed traders often take long positions, buying undervalued assets in anticipation of a markup phase. They look for signs of a potential upturn, like increasing trading volume or bullish divergence in technical indicators such as RSI or MACD. Platforms like FXOpen’s native TickTrader offer such technical tools for recognising and capitalising on market cycles.

Riding the Markup Wave

Once in the markup phase, traders may employ trend-following strategies like moving average crossovers to seize the momentum.

Short Selling in the Distribution Phase

Recognising the onset of the distribution phase is key to taking countermeasures. Traders might employ short selling to profit from declining prices. Technical indicators, such as a moving average crossover from bullish to bearish, could serve as signals for initiating short positions.

Hedging in Markdown Phase

During the markdown phase, traders often consider trend trading strategies and look for effective entry points in downtrends.

The Bottom Line

Understanding market cycles is a fundamental skill for traders, providing valuable insights into when to buy or sell various assets. Whether you're navigating the stock market or dabbling in forex, a well-rounded grasp of these cycles can greatly enhance your trading strategy. To put these insights into action, consider opening an FXOpen account to access each of the markets discussed here.

*At FXOpen UK and FXOpen AU, Cryptocurrency CFDs are only available for trading by those clients categorised as Professional clients under FCA Rules and Professional clients under ASIC Rules, respectively. They are not available for trading by Retail clients.

This article represents the opinion of the Companies operating under the FXOpen brand only. It is not to be construed as an offer, solicitation, or recommendation with respect to products and services provided by the Companies operating under the FXOpen brand, nor is it to be considered financial advice.

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