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Phases In Bull Markets

08/24/12 08:54:30 AM
by Billy Williams

Bull markets ebb and flow like the ocean tide, but there is a big difference in how a bull run begins versus the one that is in force now.

Security:   SPX, BIDU
Position:   Hold

When the markets enter a correction, the long positions that have been holding on and hoping for the uptrend to resume its direction are disappointed, with some losing hope and selling at massive losses, which only accelerate the downward move while some longs stubbornly refuse to take a loss.

During the market's descent, the once-exuberant feelings that had supported the upward move are rapidly transforming to cynicism and replaced by bitterness. It is during this time where you see major media groups and talking heads speaking negatively on the market, which serves only to turn off the majority of the investors and, to a degree, professional money managers.

It is during these times of extreme negativity that the ability to think for yourself as well as have a reliable strategy to guide that thinking is worth its weight in gold. See Figures 1 and 2.

FIGURE 1: S&P 500. Bull markets that begin after a strong correction have enormous potential, so you need to be ready when the market turns because that is where the greatest potential awaits you.
Graphic provided by:
At the maximum degree of pessimism, the market begins to find some trepid support, but most don't believe that a bottom has formed. Many were burned and still have open wounds from the downward freefall and are unable to recognize it as part of the bigger picture of things, a natural cycle of the price action that will continue on long after you and I are gone from this world.

Go to any beach and sit long enough and you will observe the tide going in and out in a rhythmic pattern. Looking closely, you'll notice that as the waves begin to form out in the water, there is a moment where it gathers enough force that it seems to spring to life and leap out of the ocean. After the initial thrust, the water begins to roll over and run into the edge of the beach before fading away.

It is that initial thrust that is like the thrust in a new bull market, springing to life and exploding upward with all the intensity of an erupting volcano until its force dissipates and fades away just as the wave that rolls into beach and is lost.

FIGURE 2: BIDU. BIDU turned upward around the same time as the overall market in early 2009 and went on to make an incredible run of almost 700% on a stock split adjusted basis.
Graphic provided by:
Slowly, price tries to creep up, attracting aggressive long positions who hope to catch a price reversal early on while others stand by for additional confirmation. As price begins to rise, nervous shorts begin to cover until enough of them begin to exit their positions en masse like lemmings running off the edge of a cliff, giving fuel to the upward move. Eventually, the bears hand the baton back to the bulls and the market begins to climb in force to the upside.

It is at this point where the most potential lies for you to get back into the market. While momentum traders will typically try to gain 20-25% when stocks move out of their base, it is at this point where stocks are most likely to climb higher than normal profit targets like these and where the real potential for home run gains await.

While you always want to be on the side of the overall market, it's the beginning of a new bull run where you have the greatest chance of making huge gains versus trying to do so after the bull run begins to roll over and lose momentum like the waves that crash into the beach. For now, adjust your stops and profit targets to compensate for the loss of steam that the market is experiencing since the current bull market has been in force for a while now.

Billy Williams

Billy Williams has been trading the markets for 27 years, specializing in momentum trading with stocks and options.

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