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Oluwole Abegunde, managing director, Meristem Securities Limited, gives an insight into the rudiments of the capital market and the features that can signal a bullish market
The most important tool an investor needs to prosper in the capital market is not the volume of cash he takes to the market but adequate knowledge of patterns of trends and cycles of the market. Without these, he is likely to enter the market at the wrong time or stay longer and lose his investments. This is why adequate knowledge of the market is needful to grow the market and retain investors’ confidence.
Oluwole Abegunde, managing director, Meristem Securities Limited, defines capital market trade cycles as an event, such as a price high or low, which repeats itself on a regular basis and ranges from short to a long term. Cycles exist in the economy, nature and the financial markets. The basic business cycle encompasses an economic downturn, bottom, economic upturn and top. Cycles are also part of technical analysis of the financial markets. “Cyclical forces, both long and short, drive price movements in the financial markets. Interestingly, no matter what market you are referring to, all have similar characteristics and go through the same phases. All markets are cyclical. They go up, peak, go down and then bottom. When one cycle is finished, the next begins,” Abegunde says.
A market cycle shows price movements over time from a period of rising prices and brilliant performance to a period of declining prices and poor performances and back again to rising prices. Stock market cycles are the long-term price patterns of the stock market.
One major characteristics of market cycle is that it can either be bullish or bearish. Bullish market is when prices trend upward driven by a host of factors like market fundamentals, positive sentiments, among others, while a bearish market is one that prices trend downward.
Abegunde explains that features that can signal a bullish market appear when securities are highly undervalued when compared to the market fundamentals and when companies are posting impressive figures. Others are rising trend of volume of shares traded, the dominance of speculative activities because of investors expectations for high returns and the issuance of a lot of primary debt and equity issues. On the other hand, investors can discern a bearish market if securities are highly overpriced and investors’ expectations are above companies performances. In addition, panic sales, gradual reduction in volume of sales and minimal primary market activities are indictors of bearish market.
Yet, even though those cycles are permanent features of the capital market, most investors and traders either fail to recognize them or forget to expect the end of the current market phase. “But an understanding of stock market cycles,” says Abegunde, “is essential if you want to maximize investment or trading returns.”
Nevertheless, astute investors can find good stocks in any market even though it is easier in some situations than others. A full-blown bear market, where many stocks are declining, is a tough market for investors. Yet, it presents some great opportunities when recovery begins.
Markets have four phases, namely accumulation, markup, distribution, and markdown phases. However, the most significant problem is identifying which phase is in control at any particular moment.
Accumulation occurs after the market has bottomed and market is still bearish. This is when innovators and early adopters take the lead after figuring the market has bottomed and valuations are very attractive because of low prices. Accumulation is followed by the mark-up phase, which is characterized by market stability and gradual moving up of stock prices. This beckons on early majority to join the bandwagon. As the phase progresses, more investors join the bandwagon fearing they will be left out. Toward the end of this phase, according to Abegunde, late majority comes in and greed relegates reason to the backseat. This is followed by the distribution phase when sentiments become mixed as investors are gripped with fear, interspersed with hope and even greed. This creates space for sellers to dominate the market. Unfortunately, this is when the mark-down phase sets in. This stage is most painful for those still holding positions because prices have fallen below their entry price. As the phase progresses and prices plunge further, they give up their holdings to minimize their loss. He says “even though not always obvious, market cycles exist in all markets. Investors who understand the different phases of the market cycle profit the most from markets. They are also less likely to get fooled into buying at the worst possible time,” adding that “investing based on fundamentals prevents one from adverse impacts of speculative buying and selling of stocks.”
Abegunde notes that another important tool investors should arm themselves with is the knowledge of market trends. This refers to a general direction of a market or of the price of an asset and it varies in length from short, to intermediate, to long term. Those who identified the market trend make much profit because they were able to trade with the trend. A trend can also apply to interest rates, yields, equities and any other market which is characterized by a long-term movement in price or volume. He described the ability to identify when a change in market trend is occurring as one of the most important skills an investor must learn.
There are several methods to identify a possible change in trend. One of them is discerning the emergence of a new pivot point. According to him, identifying a new pivot could be done by examining clues on a chart to determine whether the probability of forming a new pivot is high. One technique is to watch for a partial retrace after a trading range has been established. “When a stock refuses to honor an established range, it usually reverses to break the trading range in the opposite direction, thus establishing a new pivot point. By picking a bottom, a trader can benefit by getting in early on a new trend,” he says.
There are three basic trends for stocks: uptrend (moving higher), downtrend (moving lower) and consolidation (moving sideways). A stock in an uptrend is defined as making higher pivot highs, and higher pivot lows. A stock moving in a downtrend is defined as making lower pivot highs and lower pivot lows while a stock moving sideways is defined as moving in a trading range making pivot highs and lows approximately along the same horizontal area on a chart. Pivot points can be a little higher or lower, but generally speaking, the stock is trending sideways. It is important to note that a consolidation base can also slope upwards or downwards.
While a partial retrace can be defined as anytime a stock retraces only a portion of its prior move, this discussion will concentrate on stocks getting ready to move out of a consolidation base. Often, when a stock is consolidating, it is moving in a trading range, as supply and demand are in equilibrium. As a stock rises to the top of the range, sellers step in thinking the stock is getting expensive. As it drifts to the bottom of the trading range, buyers step in thinking the stock is becoming a bargain. This type of trend is necessary in order to weed out participants who are not committed to the position. The trading range will stay in place until either supply or demand triumphs. Typically, the trend prior to the consolidation is continued; however, there is always the possibility of a reversal.
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Oluwole Abegunde, managing director, Meristem Securities Limited, gives an insight into the rudiments of the capital market and the features that can signal a bullish market
The most important tool an investor needs to prosper in the capital market is not the volume of cash he takes to the market but adequate knowledge of patterns of trends and cycles of the market. Without these, he is likely to enter the market at the wrong time or stay longer and lose his investments. This is why adequate knowledge of the market is needful to grow the market and retain investors’ confidence.
Oluwole Abegunde, managing director, Meristem Securities Limited, defines capital market trade cycles as an event, such as a price high or low, which repeats itself on a regular basis and ranges from short to a long term. Cycles exist in the economy, nature and the financial markets. The basic business cycle encompasses an economic downturn, bottom, economic upturn and top. Cycles are also part of technical analysis of the financial markets. “Cyclical forces, both long and short, drive price movements in the financial markets. Interestingly, no matter what market you are referring to, all have similar characteristics and go through the same phases. All markets are cyclical. They go up, peak, go down and then bottom. When one cycle is finished, the next begins,” Abegunde says.
A market cycle shows price movements over time from a period of rising prices and brilliant performance to a period of declining prices and poor performances and back again to rising prices. Stock market cycles are the long-term price patterns of the stock market.
One major characteristics of market cycle is that it can either be bullish or bearish. Bullish market is when prices trend upward driven by a host of factors like market fundamentals, positive sentiments, among others, while a bearish market is one that prices trend downward.
Abegunde explains that features that can signal a bullish market appear when securities are highly undervalued when compared to the market fundamentals and when companies are posting impressive figures. Others are rising trend of volume of shares traded, the dominance of speculative activities because of investors expectations for high returns and the issuance of a lot of primary debt and equity issues. On the other hand, investors can discern a bearish market if securities are highly overpriced and investors’ expectations are above companies performances. In addition, panic sales, gradual reduction in volume of sales and minimal primary market activities are indictors of bearish market.
Yet, even though those cycles are permanent features of the capital market, most investors and traders either fail to recognize them or forget to expect the end of the current market phase. “But an understanding of stock market cycles,” says Abegunde, “is essential if you want to maximize investment or trading returns.”
Nevertheless, astute investors can find good stocks in any market even though it is easier in some situations than others. A full-blown bear market, where many stocks are declining, is a tough market for investors. Yet, it presents some great opportunities when recovery begins.
Markets have four phases, namely accumulation, markup, distribution, and markdown phases. However, the most significant problem is identifying which phase is in control at any particular moment.
Accumulation occurs after the market has bottomed and market is still bearish. This is when innovators and early adopters take the lead after figuring the market has bottomed and valuations are very attractive because of low prices. Accumulation is followed by the mark-up phase, which is characterized by market stability and gradual moving up of stock prices. This beckons on early majority to join the bandwagon. As the phase progresses, more investors join the bandwagon fearing they will be left out. Toward the end of this phase, according to Abegunde, late majority comes in and greed relegates reason to the backseat. This is followed by the distribution phase when sentiments become mixed as investors are gripped with fear, interspersed with hope and even greed. This creates space for sellers to dominate the market. Unfortunately, this is when the mark-down phase sets in. This stage is most painful for those still holding positions because prices have fallen below their entry price. As the phase progresses and prices plunge further, they give up their holdings to minimize their loss. He says “even though not always obvious, market cycles exist in all markets. Investors who understand the different phases of the market cycle profit the most from markets. They are also less likely to get fooled into buying at the worst possible time,” adding that “investing based on fundamentals prevents one from adverse impacts of speculative buying and selling of stocks.”
Abegunde notes that another important tool investors should arm themselves with is the knowledge of market trends. This refers to a general direction of a market or of the price of an asset and it varies in length from short, to intermediate, to long term. Those who identified the market trend make much profit because they were able to trade with the trend. A trend can also apply to interest rates, yields, equities and any other market which is characterized by a long-term movement in price or volume. He described the ability to identify when a change in market trend is occurring as one of the most important skills an investor must learn.
There are several methods to identify a possible change in trend. One of them is discerning the emergence of a new pivot point. According to him, identifying a new pivot could be done by examining clues on a chart to determine whether the probability of forming a new pivot is high. One technique is to watch for a partial retrace after a trading range has been established. “When a stock refuses to honor an established range, it usually reverses to break the trading range in the opposite direction, thus establishing a new pivot point. By picking a bottom, a trader can benefit by getting in early on a new trend,” he says.
There are three basic trends for stocks: uptrend (moving higher), downtrend (moving lower) and consolidation (moving sideways). A stock in an uptrend is defined as making higher pivot highs, and higher pivot lows. A stock moving in a downtrend is defined as making lower pivot highs and lower pivot lows while a stock moving sideways is defined as moving in a trading range making pivot highs and lows approximately along the same horizontal area on a chart. Pivot points can be a little higher or lower, but generally speaking, the stock is trending sideways. It is important to note that a consolidation base can also slope upwards or downwards.
While a partial retrace can be defined as anytime a stock retraces only a portion of its prior move, this discussion will concentrate on stocks getting ready to move out of a consolidation base. Often, when a stock is consolidating, it is moving in a trading range, as supply and demand are in equilibrium. As a stock rises to the top of the range, sellers step in thinking the stock is getting expensive. As it drifts to the bottom of the trading range, buyers step in thinking the stock is becoming a bargain. This type of trend is necessary in order to weed out participants who are not committed to the position. The trading range will stay in place until either supply or demand triumphs. Typically, the trend prior to the consolidation is continued; however, there is always the possibility of a reversal.