Understanding ups and downs of a bull market
July 3, 2013
Most investors don't realize that even in bull markets, severe corrections can still take place without violating the premise of what makes a bull market.
What I mean by that is, take the typical stock market. Investors tend to think bull markets always have to rise in price to signify that a bull or up market is indeed continuing.
Technically speaking, this is far from the truth. Bull markets usually have significant and ongoing price increases, but to really be a true bull market, severe corrections can and usually do, take place. It's sort of like back filling. Prices that continually rise are more like bubble markets, usually end badly and cannot be sustained over long periods.
A straight lineup in prices signifies an irrational exuberance and that investors have tossed caution to the wind. These linear price actions that rise like rockets on the Fourth of July are not a sign of a true bull market but of a market that has left reason behind and morphed into mania.
Our recent real estate market comes to mind. It had little or no pull back over its life span and with this unrelenting meteoric rise came the catastrophic fall.
True and healthy bull markets rise in fits and starts, up strong one day, then correcting some the next.
This up and down motion in price with a tendency toward always ending higher over a long period of time are the way true bull markets rise.
It is said bull markets rise on a wall of worry, a worry that they may fall anytime, but its long-term trend is always up. Corrections take place all along the rising curve, and it's these corrections that are the back filling of the price rise before it.
The corrections are investors who got in earlier taking profits, and severe corrections tend to wash out what is called the "weak hands," those that don't have the stomach for quick routs in price action. Smart investors know that by holding through these corrections, or even buying more, is the way to the big money.
Skittish investors tend to sell on brief falls, giving up their shares to those who see the real trend. Severe corrections can give back almost half of the total increase and still qualify as bull markets.
It's these dramatic corrections that can cause even the most savvy investor to question his or her positions and as to whether the end of the bull has arrived.
It's hard to tell just when a bull has ended, and therein lays the problem.
How do you know when to sell and if the bull is truly exhausted?
By focusing on the reasons the bull took flight in the first place is one way you can get a feel as to what is to come. Find the underlying reason the asset began to rise and stick to that.
If the initial reason or reasons still exist, a drastic price fall might only be the market's way of trying to fool you.
This article expresses the opinions of Marc Cuniberti. He hosts "Money Matters" on KVMR FM 89.5 and 105.1 FM on Thursdays at noon. His website is http://moneymanagementradio.com
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