Trading Stock Cycles In the Era of Demonetisation

Apurva Sheth

Normalcy is a rare commodity these days.

Just when we were beginning to settle into to the new world order, the RBI says that one can make a deposit of more than Rs 5,000 (only once per account) in the banned 500 and 1,000 rupee notes...and that too only after one explains in the presence of at least two bank officers why he couldn't do it earlier. And the banks will have to keep a record of the explanation to facilitate an audit at a later stage.

Banks were already overloaded with work and now they have the additional task of 'investigation'. This marks yet another flip-flop of the withdrawal/exchange rule since 8 November.

What does the RBI or government achieve with this?

Nothing much. Most of the black money in circulation is already deposited through other means. On 7 December, the RBI reported that nearly 75% (Rs 11.5 trillion) of the demonetised notes is already back with the banks.

Current reports say Rs 13-14 trillion is already back with the banks. If that's actually the case, then it seems the latest flip-flop is to deter people from depositing money with the banks. A face-saving effort.

Anyways, these flip-flops should not deter us from making money. Remember: As traders, we shouldn't be bothered about any of this at all. We should only be concerned with price.

Price moves in a cyclical fashion. It rises, falls, and then rises again. There's a reason Benjamin Graham quoted Horace on the first page of his magnum opus, Security Analysis......

Many shall be restored that are now fallen and many shall fall that now are in honor.

Stocks move up and down in predictable cycles. These cycles have a proper structure. A cycle from one bottom to another bottom can be divided into phases.

A stock, or for that matter any other financial instrument (bonds, currencies, commodities), goes through this cycle without fail. This is true in financial markets across the world. This is why it is considered as the holy grail of trading.

Four Phases in A Cycle

All stocks (and other financial instruments) go through these four phases repeatedly:

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

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

  3. Distribution - Common investors start to participate in the stock. Smart investors start to exit. Every subsequent high becomes more difficult.

  4. Mark-Down - Lack of substantial up moves unnerves participants. They begin to exit the stock, leading to a vicious cycle of panic and downtrend.

I have written about the four phases of a cycle in detail in the following articles:

Cycles exist. And if traders can correctly identify them, they can make money. But knowing that isn't enough. We must also know why these cycles exist. And there are two reasons:

  1. Natural cycle of creation and destruction
  2. Stock markets are artificial entities. But they are run by individuals who come together and make a market. Individuals are part of nature. And the cycle of creation and destruction has been in existence since the Big Bang. Stock markets are just a small part of the larger scheme of things. The rules that govern the universe also govern stock markets.

  3. Reversion to the mean
  4. Every stock has an intrinsic value. We can calculate that value using a number of methods. Results, however, will differ depending on the method and parameters we use. But if we average out the results, we get a fair estimate, or broad consensus, of the intrinsic value.

    If stock markets were completely rational, then stock prices would trade very close to this mean of intrinsic value. But markets aren't always rational. They overshoot above or below the mean based on pessimism or optimism.

    Eventually, though, they do realise the true value and revert to the mean. It may take market participants a long time to realise that prices are far from its intrinsic value. But as more and more of them do, the price will shift back to the mean. This reversion to the mean is the cause behind cycles.

Reversion to the mean

These cycles are an inescapable part of the markets. No matter what strikes the markets - Demonetisation, Trump, World War, Fed, RBI - these cycles will remain. As long as markets are open and free, they will exist and present opportunities to make money to those who have built processes around them.

At Swing Trader, we use these cycles to recommend trades to make money from a short-term perspective. But these same cycles can also be used to make money from a longer-term perspective.

More on that next time...

P.S: Just as I finish writing this, I hear that RBI has gone back on its rule yet again. Now depositors with a KYC registered account won't be questioned by the bank on deposits above Rs 5,000. I am being told that this is the 60th amendment... no wonder people are giving new acronyms to RBI - Roz Badlega Instruction and Reverse Bank of India.

Have you studied long-term stock cycles? Share your views in the Club or share your comments here.

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2 Responses to "Trading Stock Cycles In the Era of Demonetisation"
Suren
25 Dec, 2016
This is really wonderful pattenr and chart flow of stock movement life cycle, thanks Apurva for sharing it, but I think for most of Investor or trader like me its difficult to track those chart as we don't have any softwre tool for pttern reding or trend analysis, I think that is where we relly on EM and ofcourse we do learn lots of things when reading these article. I am often think when should I become someone to not depend on my Job even though its higly paid and my abroad stay keep extending, at certain stgae I am starting to track my finnace like my company does like tracking my spending, profit, capital expenditure and others, and start thinking likme a Fund Manager managing my own fund and measure the NAV at each 6 months, really all these recommendation from EM helps me to maximize my NAV growth, thanks and keep sharing your value commensts and strategises..Like 
RAJKUMAR S D
24 Dec, 2016
Sir, Your article explains trading cycle for each stock, no doubt it is very helpful for trading and even for short term investment purpose. But how and when such phases of trading cycle begins and how to identify them and their periodicity is important. Hence I feel that technical charts patterns for each stock for different periods will help to solve this mystery. One should interpret technical charts of pricing regularly to get an idea of accumulation and distribution with different oscillators. Thanks with regards Rajkumar s diLike 
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