Like many other facets of life stock markets move in cycles. When prices are rising it is known as a bull market and when they are falling it is called a bear market. Similarly, a person who expects prices to rise is a bull and one who expects them to fall is a bear.
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At the beginning of an upswing, share prices react to improving economic conditions. As the improvement gathers strength buyers become more confident and prices rise. Eventually, buyers become over-optimistic, they only see the good news, and many people who never bought shares before are tempted into the market as an easy way of making money.
Too high a price is put on the future and inevitably there is a reaction. Optimism gives way to pessimism and prices fall. After a while the pessimism is overdone and a new bull market begins. This is an over-simplified description of the cycle as you will discover later. But the bull and bear cycle is the primary factor in making money in the stock market.
Before you enter into any deal you should decide quite definitely whether the market is in a bull or a bear phase. Then go with the market. Never buck the trend.
If the market is in an upswing go ahead and buy the share or shares you fancy, but if it is in a downswing do nothing. Keep your money on deposit.
True, it is possible to make money in a falling bear market by various methods such as selling shares you don't have and buying them later when the price has dropped, known technically as selling short. But these kind of deals are best left to the experienced operator. The small operator is wise to adopt an attitude of masterly inactivity during a bear period.
The trouble is, when you have been in the market for a little while and hopefully made a few pounds, it is not easy to sit on your hands. This is especially so when you see the prices of some of your favourite shares drop by 30 or 40 per cent. But learn to be patient and you will reap your reward.
How long does a bull or a bear market last?
Answer: history shows that it can be anything from one to 15 years. Professor Jevons, who had a theory that sun-spots have some bearing on commerce and the state of minds, believed that the normal time for the full cycle was ten years. His theory seemed to be borne out by the facts for a long period in the last century, but more recent movements have been less regular. The stock market stubbornly refuses to confirm to any pattern and just when some bright spark thinks he has found one, it goes off in a different direction and makes a fool of him.
To what extent does the market rise or fall during these periods?
Answer: it is limited only to the sentiment of the investors. You will have heard of the 1929 Wall Street crash and the panic that ensued. Fortunately, there has been nothing as bad as that since.
The $64,000 question is, how do you determine that elusive moment when the market is about to change direction?
Answer: You can prepare complicated charts. Or you can follow the so-called experts in the newspapers and on the radio. The trouble is that the main characteristic end of a rising bull market is when the opinions of financial journalists, stockbrokers, chartists and other investment advisers are rampantly bullish. They believe share prices will continue to rise just that little bit longer.
So, the other alternative is to use your own judgement. Your feel for the market. You know what is going on in the world. Take note of the experts, but why should they be more right than you?
The end of a bull market represents a period when nothing can justify the prices at which shares are changing hands. People buy anything that is going up regardless of the share's earnings or its intrinsic worth. It's a time of greed and excitement. It seems that everyone has a stock market tip.
You might think that these conditions would be easy to recognise, but in practice it is harder to spot the end of a bull market than the end of a bear market. You are carried along with the euphoria.
The picture of the final throes of a bear market is in stark contrast: black despair. Company dividends are being reduced and there is talk about this company or that going broke. Shares are selling well below their true worth.
The average investor is tied up with shares he bought in happier times and at a much higher price. Even so the future looks so gloomy that some investors will sell and take big losses. The wise long swing speculator has sold out long ago. Now he has cash in the bank and is ready to step into the market and make a killing.
It is a banker's axiom that a bank deposit account is twice as safe as earnings from equities. So, to establish whether shares are high or low relative to their worth, take the bank deposit rate and deduct the current inflation rate to find out the real rate of return. Double this figure and compare it with the average dividend yield on equities as shown in the Financial Times or other main financial magazines.
For example if inflation is 2 per cent, the deposit rate is 4 per cent, then the real return is 2 per cent. Twice 2 per cent is 4 per cent. So provided the yield on equities is above 4 per cent, equities continue to appeal. If the average yield on equities is under 4 per cent, the indicator shows that you would be advised to keep your money on deposit. Remember this is an indicator, not a golden rule.
You can be fooled by minor movements or corrections in the market. The market does not go straight up in a bull period and straight down in a bear period; there are swings within swings. Often a sudden upsurge in prices will be followed by a fall caused by speculators taking their profits. As a general rule a bull period is in force if the market falls but then rises within a few days to reach a point higher than its previous high point.
For example, if the FTSE100 share index drops from 6,000 to 5,500 but then recovers to 6,400, its highest point ever, you can assume that the 'bull is still running', the market will continue to rise. Similarly, if after a rally the market drops to a point lower than its previous low then the bear is still hunting. These minor swings provide money making opportunities for the experienced speculator.
Gerald M Leob, who made a fortune on Wall Street some 40 years ago, wrote: 'There is no rule about anything in the stock exchange save perhaps the one that the key to market tops and bottoms or the key to market advances or declines will never work more than once. The lock, so to speak, is always changed. Therefore, a little horse sense is far more useful than a lot of theory.' Don't try to be too clever or greedy. You can do very well if you stay on the bull for a good part of his run and jump off when he gets too excited. Nathan Rothschild, when asked how he made his fortune, replied: 'By selling too soon.'
As for the bear, make sure he has gone before you venture out. In his case it is better to be late and sure than early and doubtful.
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