The life cycle of a stock

Recently I read a very good article titled "The key to the big money" published by Mike Swanson. He is the author of the Wall Street window. His ambition was to become a history professor and was more interested with the historical events, to be precise, the behind scenes of these events. Over a period of time, he felt the need to learn economics and slowly developed interests in the financial markets.

What a nice way to enter the stock market from historical events to economics and to financial markets!!!!. The author highly recommends the book "Secrets for Profiting in Bull and Bear Markets." by Stan Weinstein and I have started my quest for that :-)

I read part 1 and 2 of the same article and I am waiting for the rest. The article put in simple terms takes you through the life cycle of a stock in the stock market. In a glimpse, it talks about the different stages a stock goes through, the parties involved, support and resistance levels of a stock, volume it trades and in the end, the average investor always loose money.

The stock price depends on the basic supply and demand equation. As the demand for the stock goes up (there are more buyers in the market compared to the sellers) the stock value goes up and visa versa. For any stock there is a resistance level and a support level. Resistance level is the level above which it’s difficult for the stock to go up and the support is the level below which it’s difficult for the stock to go down. To put it in other terms, the support is the level at which there is a great demand for the stock and hence a lot of buying will happen. So it’s difficult for the stock to come further down. Resistance is the level at which sellers are more inclined to sell the stock and hence it’s difficult for the stock to go up.

The idea here is to identify the trend a stock follows and invest depending on that. As per Weinstein, the stock has the following four phases as shown.




* - This graph is directly taken from the published article.

1) Stage 1 ** Stock accumulation **
Usually this stage is started after a long decline of the stock. During this period the stock is kind of dead, not much activity, no big news, no big volumes and the demand - supply is almost even. The big guys (insiders and the institutions) with smart money identify the potential of a stock and its bright future towards the end of this phase. Me as an average investor, doesn’t have access to the knowledge base which the big guys are having and hence ignorant about the future prospects. Towards the end of the stage, the stock moves from the average investors to the big guy’s hand. They will start accumulating and slowly you can see the volumes picking up.

2) Stage 2 ** Mark up **
Now starts the fun. During the end of stage 1, the stock starts moving up. The smart money is in and there are no sellers. This breaks the resistance levels and the stock moves up. At this point, most of the stock holding is with the big guys. As the stock moves up, the fight starts between the big guys for accumulation and the stock further goes up. Now the good news about the particular stock is out and the stock brokers/analysts put a buy recommendation. Average investor sees this and starts buying at the peak price. End of the stage 2.

3) Stage 3 **Stock Distribution**
The stock is highly priced and there are lots of individual investors (guys like me :-( ) as the buyers. As the time goes, the stock stops advancing due to various reasons like the good news about the company is forgotten, the stock is heavily priced etc. The smart folks decide to sell the stocks and book the profit. End of Stage 3.

4) Stage 4 **Stock Liquidation**
Stage 4 starts with the prices coming down. There are more sellers than buyers and price keeps falling. The average investor keeps buying at each correction thinking that it will go back up. For the average investor, the start of this stage still looks good as the companies fundamentals are good, growth prospects are healthy etc. Even the brokers /analysts have the buy recommendation on it. Phase 4 ends with the average investor holding the stocks bought at the peak. Over a period of time, the average investor sells it in panic and this cycle continues.

During this cycle, the best time to buy is the start of stage 2. The average investor doesn’t have access to the information to identify whether the stock is at stage 2 or not. We can identify this cycle by watching the volumes and looking out for the big players.

The article ends with the following logic, it’s always better to follow the smart guys instead of the analysts / brokers. I always used to select a stock taking into account the fundamentals of the company but now after reading this article, I started appreciating the beauty of technical analysis and charting. I am waiting for the next parts of the same article. Will keep you posted.