The 4 Phases of the Stock Market

October 20, 2022No Comments

Today we’re going to go back to some basics. If you’ve taken my online trading course, and I do strongly recommend that you take it if you have not, it’s just a few hundred bucks, I think it’s about $390 and it’s the best $390 that you will ever spend. People waste tens of thousands of dollars on holding stocks for too long, buying them at the wrong time, or placing money into the stock market or listening to the buy-in hold propagators, and yet won’t spend a couple of hundred bucks on teaching themselves to stop doing those terrible habits and stop losing so much money. My course helps you avoid those mistakes, and I’ve literally put everything you need to know to be a far more effective trader into that course.

It’s a brain child that I came up with about a year ago, and I think it’s the most important work that I have ever done. So I’ve priced it very, very low so you can access it and if you are a do-it-yourself investor, you need to take this course full stop. Anyhow, if you’ve taken the course, you will remember that near the beginning of the course, I talk about the basics, which are the four phases of the stock market. So we’re going to do a little bit of a deep dive on that today. Now, again, you need to take my course because I’m going to be talking just the highlights.

There’s four phases of the market. Really what you could call them is a basing phase and then an up trend and a down trend filled in with a topping phase. So these phases occur in the markets because of human psychology. People think that, well, with all the computerized trading and all these different things that things are different these days, the new slow, etc. It’s true things move much faster than they used to move despite the computerized trading. The computerized trading, they move on second by second trades. They’re not interfering with the longer term trends, which always comes down to the big money managers and retail investors and how they’re moving within the grander trends. So don’t get all tied up over some of the new program trading and stuff that you’ll hear about. Yes, the program trading messes with your inter-day pricing and sometimes gives you a lousy fill on your buy and your sell because they’re messing with you during the day.


But the longer term trends are dictated by human emotion. So these phases represent the phases of human emotion. So there is a bottom where market confidence is starting to return and then an uptrend enthusiasm, and then there’s usually some sort of a top, in a panic it moves down and then you move into the full on down trend. That’s the discouragement phase. Where are we right now? I believe we’re in the discouragement phase. I’ve talked about that on a blog just recently, and I suggest you rifle through some of my very recent blogs and you’ll see notations on this. But let’s take a look at some of the indicators that can help us identify what phase we are in.


And the most important indicator, of course, is always going to be the trend. I want to really focus on the past two major bear markets. There was a topping phase, phase three. There was a down trend. There was a base after the 2000 to 2002 market bear and that base was illustrated by a sideways consolidation period. A candle with a long wick on it is called a hammer, and the hammer is a sign of a capitulation. So the capitulation hammers, we got a couple of them. There was one in early, probably around March-April of ’02 and then there was a another one during the summer and there was even a final one that marked the actual bottom early ’03.

So you’re looking for long wicks and that is coinciding with sentiment and momentum capitulation, but I want you to get a handle on that this pattern repeats over and over again and you can see long candle wicks mark the bottom because they are washouts and the market turns around, and that always happens at the bottom of bear markets. Now 2020, some people call that a bear market. I’m never sure if I should call it that because it’s hard to say that that was a bear market. It was fairly deep and it had the washout candle that I’m looking for, that long wick inter-day reversal. I believe that was March of ’20 or April it might have been.

But otherwise you didn’t get the steps of recoveries followed by selloffs that you get in traditional bear markets like we had in the 2001 to 2002 and 2008 to 2009 bear markets. We are getting those steps down but we’re not getting any wash out candles, and it’s not as deep and as built yet as the previous two bears. Now it doesn’t mean that we get another bear that looked like the first two. I mentioned in a blog that no two bears are alike. You can’t just say, well it looked like this and therefore it’s going to look like that again. It’s going to resemble but not absolutely mirror what has happened in the past. So how do we tell? We are probably in phase four. We’re in a bear market where we’re in a down trend. Anybody that wants to argue with me on that, I think I’ll win that argument.


And I don’t think any of you are willing to argue that we’re not in a down trend. We’re below the 200-day moving average. We’re making lower highs and lower lows. What more do you want? We’re in a down trend. The question is, when does phase one come in? Now we haven’t seen that candle yet where you get the big long wick so that’s one piece of evidence that we’re not there yet. Let’s look at another piece of evidence that may be encouraging, but we need to see all the ducks line up. So there is another type of indicator that I look at and it’s an indicator that I tend to use for big picture analysis. It’s the percentage of stocks that are above their 200-day moving averages in the S&P 500. Now the S&P 500 has something like 510, 512 stocks.


It’s not actually just 500 stocks, but to keep it simple, it’s about 500 stocks. So back in 2021, we had something well over 90% of stocks that were above their 200-day moving average. Nothing could go wrong. The market was going up and it was never going to go down again. That’s the attitude during these phase three tops. They can last a while. During the mid 2011 to 2015, just before the market fell apart in late 2015, early 2016, the phase three sign of lots of stocks trading above their 200-day moving averages, it lasts a while. So it did last a reasonable period of time this time again. But once again, it finally moved into a top and then a phase four down trend.


The question is, are we at a level one washout yet? Well, remember that we don’t have that long wick candle, and we did get those long wick candles and even in 2020 we had that long wick candle. So it’s pretty deep. The number of stocks below their 200-day moving average did reach around 12.5%. That’s not a lot of stocks as a percentage of the S&P that were above their 200-days. So it was pretty washed out. That is pretty close to the levels that we’ve seen in other bears. You get small spikes like this, but I’m looking for the deep ones and it was pretty close to say the 2002 washout, but it’s to be seen if this is going to coincide with the washout date, which will be illustrated by a hammer or some sort of a candlestick that looks like that.

So let’s take a look at another piece of evidence. So we have a growing piece of evidence that the market is becoming despondent and that’s seen in the number of stocks below their 200-day moving averages. So let’s take a look at a true sentiment indicator, and that is the VIX. Now, again, I’m just highlighting. You need to take my course to hear all of these indicators, and you might also want to pick up a copy of my latest book called Smart Money Dumb Money, because I cover all kinds of sentiment indicators in that book. But I’m going to just focus on phase three, which is the top and phase one, which is the bottoming process. You’ll notice it’s reversed.


That’s because the VIX is a fear index. It represents the premiums that options traders are demanding on their options as they write them. So the more volatile the market is, i.e. the more it’s going down, the more premium they want because they don’t want to be left hanging to dry and having to buy a stock off of you at a worse price than they wrote the option for. In the tech sell off in 2002 and even earlier than that you got some kind of pessimistic washouts and then a bottom and on and on it goes. Remember in 2016, people were very complacent coming into the 2015-2016, and then it washed out and you can see the market, moved into an overly pessimistic period by early 2016.

We saw an overly pessimistic period in 2020, and that lined up with the other things we just looked at with that spike hammer formation and all that stuff. And then it moved into the bull phase, phase two and then finally a period of complacency. Now notice this period of complacency wasn’t as deep as some of the others in 2021, nevertheless it was down there. Since then the market has been moving down after that top. Remember, complacency is a topping period. So after that topping period, we’ve become more pessimistic about the market and that shows up as the VIX moves higher and higher. So we’re calling that phase four, which is the down trend as pessimism grows. What we are not seeing is a washout on the VIX like we have at the bottom of other bear markets.


We’re getting some washout in the number of stocks that are trading above their moving average, but we’re not getting a candlestick with a big washout stick and we’re not getting the VIX, which typically spikes way over 30. And I mean like into the 45 plus area is typically the bottom of a true bear market. Now, again, no two bear markets are alike, but history shows us if we go right back to 1990, typically big bad bearers like we’re in now finish up with an ugly capitulation point. And that capitulation point can sometimes only last a day like it did in 2016 and it did in even 2020. There was a few days there where it stayed above 35, but there was one biggie where the VIX went quite high as it did in the 2009 March bottom.


So we’re not even near that yet. I mean, we see the VIX is high, but it’s not at full on capitulation. So bottom line in today’s lesson, if you will, is that some of the signs are there. I like to say there are some signs of green shoots as some market pundits like to say as well. So there’s green shoots appearing because we have a washout look in the number of stocks that are below the moving average, but we’re not there when we look at the chart formation yet. We’re not seeing a washout candle. We’re not even seeing a base where it moves sideways for a bit. And we’re definitely not seeing a sentiment washout, at least according to the VIX. I can tell you we’ve not also seen a washout on many of the other indicators, including the put-to-call ratio and a few others that I talk about in my course and in my books. So bottom line, we’re getting close. We are getting close because I’m seeing it on the market breadth indicators like the percentage of stocks over the 200-day and a few others. But we’re not there yet. When will we be there? Time will tell, but I don’t think it’s six months or a year from now. I think it’s weeks to maybe a couple of months. Could even be less time than that but it’s not here as we speak. Thanks for watching. See you next time.


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