An understanding of how markets work and a good grasp of technical analysis can help you recognize market cycles. Market cycles include a number of phases of market growth and decline, which is driven by business and economic conditions. They are patterns that aim to indicate when new trends in an economy, market or industry have developed.
We’ll enter stages where chasing big returns is relatively easy, and we’ll enter stages where what appears to offer big returns is nothing more than a trap. There will be times when we actually want to earn less than the market average in order to ensure that we don’t get wiped out before entering the stage where we intend to earn the most. We’re going to discuss these stages in detail. We’ll learn how to identify them and how to invest in each of them. We’ll also gain an understanding for the amount of risk we should assume at every stage in the cycle.
It’s not surprising that most investors think the market is risky when it has no place to go but up, and they think the market is safe when it’s drastically overpriced. Like I said, most investors aren’t engaged, and they don’t really need to be. We, on the other hand, will be very engaged. We’ll be rewarded for our engagement, but we’ll also make some mistakes along the way. Every investor does.
The more we try to time the market, the greater the probability that we’ll make mistakes. We can take measures to limit the impact of our mistakes, but mistakes can’t be completely eliminated from the equation. We’re human beings after all - we all make mistakes like buying the wrong gifts for our loved ones. A successful investor acknowledges their mistakes and is quick to close a losing position. Others like to hold on to their mistakes in hopes that the tides will eventually change course. It never pays to argue with the market. When you make a mistake, own it. Then analyze what you did wrong so you won’t do it again.
If you really want to reduce the probability of making a mistake, learn to identify the stages of the secular market cycle. This will help you tremendously. It enables you to distinguish between movements that create opportunities and movements that will sucker you into a losing position. It’s complicated because no two cycles are exactly alike. The market moves in prolonged secular cycles, but within each secular cycle is a series of cyclical cycles. The duration of these cycles typically conforms to an observable range—like everything else in life, there’s a measurable average—but that doesn’t mean that cycles are static. Each cycle is different, and the average is constantly evolving.
We’re not going to implement strategies that require us to predict the turning point of a secular cycle. It’s too erratic. So instead we’re going to implement strategies that only require us to recognize the approximate stage of the cycle. This is much easier to do and it’s something we can be successful at.
There are going to be stages in the cycle where discounts are popping up right and left. We’ll invest everything we have and we’ll wish we had more to invest. But we can’t always wait for the position of the market to be perfect. Sometimes we need to be more aggressive than other investors, and sometimes we need to be more defensive. It all comes down to the fact that we want more.