How to earn profits in different cycles of the stock market?

Blog | TRADING 101

In the last 20 years, there have been various cycles in the stock market which have been bullish as well as bearish. For example, the stock markets were in a down cycle post the year 2000 when the tech stocks started a meltdown. Between the years 2003 and 2007, markets were in a long-term bull cycle before getting into a one-year bear cycle. There was a major bull-rally, starting in the year 2014 and extending all the way to the late 2015. Frankly, these cycles are extremely hard to predict. To profit from market cycles, you need to understand the structure of the cycle, first. Let us look at a strategic approach to four such cycles:

How to profit in a secular up-cycle?

These up-cycles typically last for periods ranging from a year to as long as five years. The key rule is that every cycle is driven by a theme or a set of stocks. For example, the 1992 rally was about cement, 1999 rally about IT, and the 2007 rally was about realty and infrastructure. The best way to profit in a secular up-cycle in the market is to stick to these market drivers. Remember, secular up-cycles are not immune to corrections. In fact, there could be a series of corrections, ranging from 10% –15%, but the logic in a secular up-cycle is to use dips to accumulate more of these trend drivers. Don’t make the mistake of selling futures or going short on these driving themes.

Making profits in a structural down cycle

This is easier said than done because profiting in a structural down-cycle requires a lot of counter-intuitive thinking and also a lot of unconventional courage. Normally, such structurally-down cycles immediately follow a major rally. We saw such down-cycles in the years 1992, 2000 and 2008. The first way to be profitable during such times is to exit the sectors or themes that triggered the rally in the first place. In the past, no two rallies have been driven by the same set of stocks or the same theme. It just keeps changing. Secondly, you can either sell futures or if you want to reduce your risk, you can also look to use put-options on the stocks that are most vulnerable. When the market is in a down cycle, it is normally called a “sell on rises” market. You must use every bounce in the market to sell more.

How to be profitable in a cycle of volatility?

There are times wherein the market may be within an overall trend but then it may happen in the midst of high volatility. How do you handle this situation? Firstly, don’t change the basic structure of your trade. Instead, shift your holding pattern from small caps to larger players. Also, look to shift your holdings more towards quality stocks with proven track records. They normally handle volatility best. You can also use derivative strategies like straddles and strangles to profit from these cycles of volatility. It is usually marked by a sharp rise in the Volatility Index (VIX).

How to be profitable in lackluster markets?

This is not the market to be too adventurous but rather you should consolidate. High beta-stocks may not really work and the typically defensive sectors like FMCG and IT are more likely to be profitable in such markets. You can also look to use derivative strategies like reverse strangles and reverse straddles to make the best of lacklustre and covered-calls to reduce your cost of holdings. This is when you can profitably bide time and hope for better performance from defensives. The key to investing is all about having a game plan for each cycle and gauging the structure properly. The rest will follow!