Bull Market Anatomy

Who does not like Bull markets? Every one of us is very eager to ride the wave up a bull market. Though it is possible to make money out of a bear market, it is easier and seems more natural to make money off of a bull market. The traditional saying of "Buy low sell high" can be easily implemented in bull markets and so can the momentum trader's saying "buy high sell higher".

A good jockey takes time and effort to know more about his horse and the turf. Similarly in order to ride a bull, you need to better understand bulls, its behavior patterns and its turf which in this case is the state of economy. Let us focus on understanding the general nature of a bull market in this post.

A primary uptrending bull market can be generally divided into 3 phases. The first phase begins when distressed selling is still continuing and stock market continues to be weak. Financial Reports coming out are still bad and there is only moderate activity going on in the market. Having gone through a rough bear market, an average Joe is still thinking about the safety of his investment assets and he still is not able to see the bottom of the stock market. During this time of under-valuation, Smart money led by far sighted investors pickup the oversold condition in the stock market at a bargain price. Many call this phase as Accumulation since smart investors like Corporate insiders and other smarter investors with insight into companies prospects will grab their share when everyone else is trashing them. This kind of buying should stop the stocks from further falling and many times, this will increase stock prices by moderate amount.

In the second phase, the buying activity picks up due to improved business situation and better corporate earnings. Many times Feds intervention helps provide better economic conditions for this kind of growth. When the safety of stock investment increases, bigger institutions like Mutual funds move their big money in millions of dollars into the market. By now the stock market might not be under valued anymore. The stronger trends provided by bigger institutional money can fuel sustained growth in the market. The buggers who moved their smart money in the first phase are now counting their huge windfall profits already.

The third phase is the party time when Tom, Dick and Harry all join the celebration. The retail investors are not sophisticated and they get their investment tips from friends, financial magazines, and from internet websites. Any financial news are good news and price advances are spectacular. Speculations of retail investors run rampant and the stock prices rise on huge volume. During these times you might recollect that your friends and colleagues talk about various stock picks or may even brag about their last victory they had. It is usually in the third phase when an average joe talks about his stock picks and that is when he throws all cautions into the wind and becomes greedy. Even some stock analysts think that this bull market is different from previous ones and recommends BUY signal for their picks. This phase is also a good time companies going IPO since the over enthusiasm in the market can get them a good price for their stock. The market sentiment is ripe for maximising their stock prices. As this phase matures, the smart investors recognizes overvalued stocks and overconfident investors and hence they start unloading their investments into the market. But average Joe still oblivious to the selling by smart money, is buying actively in the stock market.



The picture above shows the chart for S&P 500 starting from 2002 till now (Aug 2007). This picture shows the graph for a primary bull market. As indicated in the picture, the smart money moved in during the later half of 2002 and in the early half of 2003 when every one else was holding tight to their cash stash. Big institutional investors moved in later part of 2003 and in 2004 providing steady growth to the market. As of this writing (August 2007) we might be in the later part of bull market or in the beginning of a bear market. Only time can confirm that. No matter what stage we are in, by just knowing the anatomy of a bull market you should be able to recognize when to move-in and move-out of a stock market.

-Nidhi

Related Posts: Anatomy of a Bear Market