Identifying Phases of a Stock

By Apurva Sheth, Editor, Profit Hunter 13 Jun 2015 ARCHIVES

Last time I spoke to you about the phases that a stock or a security goes through its life cycle. All types of financial securities (equities, bond, currency or commodity) goes
through a similar phase across its life span. This is a common factor that binds all the markets across the world.

Any financial security goes through these four phases repeatedly.

1. Accumulation - Stock consolidates in a range after a prolonged downtrend. Value Investors enter in the stock in this phase.

2. Mark-Up - Stock crosses the range resistance. A higher top higher bottom cycle is clearly visible on the charts.

3. Distribution - Common public starts participating in the stock. Smart investor start exiting. Every subsequent high becomes difficult to come.
Apurva Sheth
4. Mark-Down - Lack of substantial up moves unnerves the participants. They begin exiting the stock leading to a vicious cycle of panic and downtrend.

Knowing a theory is one thing and applying it while trading is something different. Stocks certainly go through these phases but we come to know of it only when a lot of water has already passed under the
bridge. I know that it can be very difficult at times to identify these phases correctly when you are riding a trend. There are high chances that we may get it completely wrong. What may look like a distribution
phase initially may actually turnout to be only a consolidation in an uptrend.

This happens with me even today. There isn't a foolproof method to identify these phases accurately. But that doesn't mean we shouldn't try to create our own method. We can always try and practice and improve
with time.

So let's give it a try and lay down the steps one can follow to identify the phases.

1. Look Left

The first and foremost step is to look leftwards on your weekly chart. Sometimes the phases are quite obvious on the first glance itself. It may sound superficial but once you have spent
decent amount of time the chart will speak up for itself.

I start with four years of weekly price data on my chart. I use four years of price data because it is the usual time a normal business cycle takes to complete. Stocks being part of the economy
also fits in well in the cycle. However, it isn't always necessary that a stock will complete its entire cycle in four years. At times even four years of price data isn't sufficient to get a view of
the stock. In such cases one can go further left until a cyclical pattern emerges clearly.

2. Study Last Six Months Price Action

We are doing this study so that we can make use of it on an immediate basis. I believe studying six months' worth of price action will give us enough clues as to what the stock is likely to do
in the near future.

One should try and identify whether the stock is trending or trading in a sideways range. I have spoken to you earlier about the Peak trough Analysis. This would help us segregate the stock
in either the trending basket or sideways basket. Stocks can either trend upwards or downwards. It is considered to be in an uptrend if it is forming a higher top higher bottom. A lower top
lower bottom formation would mean that it is in a downtrend. One can also use tools like trendlines and channels to identify trends.

At times there may be stocks which may not be moving in either of these direction and stay sideways. Here the peaks and troughs will be at same levels or within the previous peaks or
troughs.

3. Fitting this into the big picture

After you have identified what the stock has been doing most recently it becomes important to fit it in to the big picture. This helps us to complete the jigsaw puzzle. Just like one season is
followed by another season. Similarly a Mark-up Phase will be followed by a Distribution Phase and then by a Mark-down phase.

By identifying a phase that a stock may be going through one can probably guess what might come next. For example you may have identified that a stock is in a Mark-up Phase. An
Accumulation phase precedes a Mark-up phase which is later followed by a Distribution Phase. So once you have identified the Mark-up phase you can look left to find where the
Accumulation phase began. You can use the lows of the accumulation phase to draw trendlines or channels. If the stocks is holding above them or is currently continuing with a higher top
higher bottom cycle then the Mark-up Phase is likely to continue.

On the other hand if the stock has turned sideways after a long uptrend. Then it can possibly be a start of the distribution process. Identifying this correctly is very tricky as what looks like
distribution may turn out to be only a consolidation in an uptrend. We shouldn't worry much about it as this will help to formulate our trading strategy. For example one can simply avoid
trading in stocks which may be going through a Distribution phase and enter only when they have decisively broken out of the pattern on either side.

Volumes also helps in identifying these phases. It helps us get useful insights in identifying these phases. For example Mark-up Phase are generally characterized by rising price and rising volumes.
Distribution Phase by rising prices and falling volumes.

Identifying phases also helps us by telling which tools and strategies to use at what time. For example one can use a combination of trending strategies like trendlines, channels and moving averages to enter a
stock when it is in a Mark-up or Mark-down phase. On the other hand one can use support and resistance levels to trade stocks that are in an Accumulation/Distribution phase.

I know this will be a tough nut to crack but nevertheless we should try it atleast. Next time when I write to you I will show you a couple of examples of stocks with these four phases. I will also share a technique
that helps me keep a tab on the phases of these stocks.
Accumulation/Distribution

Accumulation/Distribution is a momentum indicator which takes into account changes in price and volume together. The idea is that a change in price coupled with an increase in volume may help to confirm market momentum in the
direction of the price move.

Note the similarity of this formula to that of the stochastic; this is basically a stochastic multiplied by volume. This means that if the security closes to its high, the volume multiplier will greater than if the security closes nearer to its
low.

If the Accumulation/Distribution indicator is moving up the buyers are driving the price move and the security is being accumulated. A decreasing A/D value implies that the sellers are driving the market and the security is being
distributed. If divergence occurs between the Accumulation/Distribution indicator and the price of the security a change in price direction is probable.

The Accumulation/Distribution Line formula is as follows:

Where I is yesterday's Accumulation/Distribution value.

What Phase Is The Stock Market In Now?
If you are a fan of Wyckoffian logic then you will understand that the stock market has four major phases: Accumulation, Markup,

Distribution and Markdown. The $64,000 question is what phase are we in now ?

Quickly, I will define each phase.

Accumulation: In short, an area where Informed forces buy stocks or futures with the intention to mark-up prices. At the same time less

informed forces tend to sell in that area.

MarkeUp: Normally appears after a accumulation period. The stock float supply has been soaked up during accumulation, and for market

players to acquire stock float then they can do so by only paying higher prices.

Distribution: In short, an area where informed forces sell stocks or futures with the intention to mark-down prices. At the same time less

informed forces tend to buy in that area.

MarkeDown: Normally appears after a distribution period. The stock float supply has overcome demand, and for market players to distribute

stock float then they can do so by only paying lower prices.

Let's review NYSE stock market index.

I believe between the swings 1 to 3 the market under went accumulation. This is clearly evident by the massive volume increase on swing 3

and the swing up volume of 3 is greater than the swing down volume of 2. Market players acquired stock float under the belief that prices will

be marked up in the future. The minor sell off tagged at swing 4, established that stock float supply was tight when demand is great, and the

only way for market players to acquire more stock float was to pay higher prices.

Swing 5 clearly can be labeled as a markup period. Volume was consistent and prices rose moderately.

Between swing 6 and 10 the stock market suffered distribution at marked up prices. This is easy to conclude as swings 6, 8 and more so 10 the

down swing volume is greater than the upswings (7,9,11).

So what is going on since Oct 2010. We know that Fed Chairman speech at Jackson Hole set up the current trend and now prices have broken

resistance at 7743 and have gained nearly 6% beyond 7743. Are we undergoing a new price mark up phase? We could be. However I suggest

that this could also be a fake price markup. Why fake, well at the moment until further evidence to the contrary the upswing at 13 has been

completed on very low volume, and so far volume has not accelerated. This (possible) false break maybe their to attract the less informed into

the market for the better informed to sell into. We will change our mind if after a minor sell off price holds above 7743 and the following push

back up is on rising volume greater than swing 13.

What to do! Wait for a sell off to 7743 (at least). Then wait for the expected recovery after this sell off. Measure the recovery for strength, and

then if all is well enter the market as this may be a true break out. If it lacks strength and is unsupported by good volume or sound

fundamentals, stand aside. For now stay on the couch and do nothing! Believe it or not doing NOTHING is an option in a successful

investment plan.

The Stock Cycle: What Goes Up Must Come Down

By Candy Schaap
Stock prices may appear random, but there are repeating price cycles, which are predominantly driven by the participation of large financial institutions.

Large institutional buying plays out in four distinct phases:

1. Accumulation

2. Markup

3. Distribution

4. Markdown

A trader must have a strategy to take advantage of price action as it is happening. Understanding the four phases of price will maximize returns

because only one of the phases gives the investor optimum profit opportunity in the stock market. When you become aware of stock cycles and the

phases of price, you will be prepared to profit consistently with less drawdown.

Accumulation Phase

The accumulation phase begins when institutional investors (such as mutual funds, pension funds and large banks) buy up substantial shares of a

given stock. Price forms a base as the shares of stock are accumulated. Institutional investors must buy over long periods of time so as not

to conspicuously drive up the price of the stock; they therefore have a long time horizon.

This phase is not a lucrative time for retail investors to buy, as capital will be tied up, or the investor may experience a large drawdown of capital.

However, recognizing the signs of accumulation gives insight to future opportunity. During this phase, price moves mostly sideways in a range. The

range is identified by variable pivot highs and lows (Figure 1) and whipsaw-type price movement.
 Figure 1: Variable pivot highs and lows and price is sideways. Notice the length of
the cycle (green highlight)

Source: TDAmeritrade Strategy Desk

The cup and handle is another price pattern indicating accumulation. The handle is a higher pivot low and may signal the end of an accumulation cycle.

A higher high in price above the rim of the "cup" can lead to a new leg up.

Figure 2: Cup-and-handle pattern during the accumulation phase

Source: TDAmeritrade Strategy Desk

The accumulation phase can wear down your capital as price will swing in both directions. Sometimes it is useful to add an indicator to help identify

non-trending conditions. The average directional index (ADX) is a trend-strength indicator, and the example in Figure 3 shows price moving sideways.

The ADX has been added to show trend strength. An ADX of less than 25 shows low trend strength, indicating non-trending conditions. The ADX rises
above the 25 level when there is trend strength. (For further reading about the ADX, see ADX: The Trend Strength Indicator. For background

information, see our Exploring Oscillators And Indicators tutorial.)

Figure 3: Accumulation phase - low ADX shows non-trending conditions

Source: TDAmeritrade Strategy Desk

Markup Phase

During the markup phase, price breaks out of range and begins a sustained uptrend. An uptrend is defined as a series of higher pivot highs and higher

pivot lows.This stage is when price begins moving up. The big money has established a position and retail investors are now invited to join in the profit

party. This is the most profitable time to own the stock - an opportunity to let your profits run. The earlier you can recognize this stage, the more you

can profit.

Use trend-trading strategies during this stage. An example of a trend-trading strategy would be to draw a trendline along the pivot lows and stay long

above the upward trendline. Entering a stock early in the markup phase leads to the greatest potential profits. Classic trend trading involves entering

the stock at pullbacks above the trendline (Figure 4). (Learn how to use trendlines effectively in Track Stock Prices With Trendlines.)
 Figure 4: Markup phase. Trends are more likely to continue than
reverse, so continue to ride the trend as long as price remains
above the trendline.

Source: TDAmeritrade Strategy Desk

The ADX helps us see the transition from the accumulation phase to the markup phase. When the ADX rises above 25 at the same time as a new high

in price, the trend may be starting. The best trends will have agreement between the indicator and price, as noted in Figures 5 and 6. The trend is truly

your friend; let your profits run. (Check out our Technical Analysis tutorial for more information.)

Figure 5: From accumulation phase to markup phase

Source: TDAmeritrade Strategy Desk

 Figure 6: Markup phase, a time of trend

Source: TDAmeritrade Strategy Desk

Uptrends occur in this cycle and price makes higher highs. When trend momentum is increasing, as seen in higher ADX peaks, we can expect the

trend to continue. Figure 6 also shows a triangle pattern in the accumulation phase and then a new price high, showing us how the markup phase

begins and a trend is born.

The price may continue the trend or enter a reversal; more often than not, the trend will continue after a test of support/resistance.

Rectangle patterns represent price consolidation and can happen when stock shares are being accumulated or distributed. Recognizing the sideways

trend leads to the best strategy for profit. An investor can be out of the trade for this period or, if there is a dividend and/or options, another strategy

might be to hold and collect dividends and sell covered calls. It is easier to identify in hindsight, but learning to recognize consolidation when it is

happening provides an edge in profit trading. (For more, see our Analyzing Chart Patterns tutorial.)
 Figure 7: Rectangle pattern, price is sideways

Source: TDAmeritrade Strategy Desk

In Figure 7, you can see rectangle price patterns in the markup phase for the Energy Select Sector SPDR (AMEX:XLE

Sel Sct En Shs

XLE

65.11

-0.99%

), which leads to continuation of the trend as seen in Figure 8. A new high in price from a rectangle pattern is a technical buy signal. A new low in price

is a technical sell signal.

 Figure 8: Continuation of trend in markup phase

Source: TDAmeritrade Strategy Desk

Distribution Phase

The distribution phase begins as the markup phase ends and price enters another range period. The shares are being sold over a period of time - the

opposite of accumulation. This time, the sellers want to maintain higher prices until he or she has sold the shares.

Whether it is distribution or accumulation is less easy to discern at this point. It is more important to be prepared for the next signal, rather than trying to

predict the next move.

One of the most common distribution patterns is known as the head-and-shoulders pattern (Figure 9). Rounding or a dome shape (Figure 10) indicates

distribution preceding the markdown stage.

 Figure 9: A three-pivot reversal, distribution of shares

Source: TDAmeritrade Strategy Desk

Figure 10: Markdown follows distribution

Source: TDAmeritrade Strategy Desk

Markdown Phase

The last phase of the stock cycle is the markdown phase. Markdown begins when price makes a lower high and no new high (Figure 9). Markdown

follows distribution, which is when institutions sell inventory, either for redemption reasons, simply taking profit, or to change position into another stock

or sector. The markdown phase is a downtrend (Figure 11).

Be careful that emotions do not rule trading during the markdown phase. Price is always the signal to watch; a series of lower pivot highs and lower

pivot lows will signal a pullback in price or a trend reversal. A reversal is when price direction changes completely from the direction it was

headed. Successful investors ensure that gains are banked, and money-management rules will not allow for holding a declining issue. (Learn to

recognize a reversal when it happens in Retracement Or Reversal: Know The Difference.)

 Figure 11: Markdown phase is represented by lower pivot highs and lower
pivot lows. This is a reversal to a downtrend.

Source: TDAmeritrade Strategy Desk

Figure 12: The stock cycle

Source: TDAmeritrade Strategy Desk

The Bottom Line

The study of stock cycles will give investors the heads-up on trending conditions for a stock, whether sideways, up or down. This allows the investor to

plan a strategy for profit that takes advantage of what the price is doing. The entire cycle can repeat or not. It is not necessary to predict it - it is

necessary to have the right strategy.

Now you can apply this information to learn to manage risk. Once you have a gain, have a plan to keep some: a gain is not a profit until you bank it.

You can use a stop-loss as part of your trade-management plan to help you capitalize on your gains.
Smart investors who recognize the different price cycles are able to take the best profit opportunities. The good news is that you can learn to make the

right trade at the right time.