The Four Stages of Stock Market Cycles

From the changing seasons to the ebb and flow of the economy, cycles are all around us. Each is driven by unique forces and made up of individual stages. Cycles and stages are also present in the movement of stocks and understanding their dynamics can help provide investors with potential insights and investment opportunities.

The four stages of a stock market cycle include accumulation, markup, distribution, and markdown. Let's talk more about each cycle.

This is the first stage of the market cycle and can be found with individual stocks, sectors, or the market as a whole. It's characterized by meandering, sideways price action that stays within a range and can last a long time, sometimes even for years.

This is the stage when institutional investors begin to accumulate shares. These are major players who need to acquire large positions but can't do it all at once for fear of driving prices higher and raising their cost basis. So, they buy at regular intervals when the stock hits their desired price levels. This supports the stock and moves it up slightly. Then they wait for the move to be digested and the price to come back to their target level before repeating the process.

During this stage, few retail investors might participate because price action is unremarkable and doesn't necessarily attract attention. On the other hand, this is where long-term investors might be able to position themselves to scale in or out of positions to take advantage of price movements.

Buying everything at once means investors might miss out on a better price the next day or the next week. A "bite-sized" approach can sometimes be a better choice than buying everything at once. However, this approach can raise your transaction costs, so take that into account.

Just as the accumulation stage is characterized by support and resistance levels containing the price action of a stock, the markup stage is identified by the share price rallying above the resistance level. When this "breakout" happens, investors often see a spike in volume. This volume spike is caused by institutions and individuals who didn't buy during the accumulation stage and are now purchasing the stock.

During the markup stage, price action can go from neutral to trending. If investors begin to see higher highs and higher lows after a price breakout, it can potentially be an indicator that the markup stage has begun. This type of movement can attract attention and, as more and more buyers purchase the stock, the uptrend typically gets stronger, eventually becoming parabolic before entering the next stage.

During the markup stage, investors can use technical analysis indicators like simple moving averages¹ to track key support and resistance levels to better help them keep track of price movements.

During this stage, and really at any point in the market cycle, remembering their original trading plan can help investors from straying from their original investing plan if things don't immediately move their way.

This is the topping stage for a stock, sector, or the market in general. The distribution stage signals that a rotation is taking place as early buyers—those who bought during the accumulation stage—as well as later buyers may begin exiting the stock.

One hallmark of this stage is an increase in volume but without an increase in price. This stage often sees the stock's highest volume because bullish sentiment is extremely high. Initially, new buyers may be able to absorb the selling, but not enough to keep driving the stock higher. In this scenario, the stock can end up collapsing under its own weight.

One way to identify this market cycle stage is through chart patterns, such as a head and shoulders top or double top. A break below the 200-day moving average can also be a confirming signal that the distribution phase has ended.

This is the final stage of the market cycle, and the one that many investors want to avoid. At this point, buyers who got in during the distribution phase and are underwater on their positions start to sell. Because institutional players are long gone, there are very few new buyers to absorb the increased selling, which can attract even more selling.

This cascading effect can send prices down very rapidly and on large volume. This phase usually ends when a critical support level is breached and volume spikes many times the daily average, at which point most net selling is exhausted and the stock can return to the accumulation stage once again.

One way for investors to learn how to identify the four stages of a stock market cycle is by studying the past chart action of various stocks on a weekly time frame.