How the Market Works- Part 1

There is a lot usually written about how the market behaves. Just like different religions usually point to the same idea of a god(s), different lenses usually tend to observe similar tendencies. To keep it simple, we use the idea that any stock or index goes through stages.

STAGE 1 BASE 'Accumulation'

Usually formed at lower level formed after a decline, a STAGE 1 BASE is where value investors, large institutions and big boys start building positions.

The decline needs to be considerable (STAGE 4) in order to yield a genuine STAGE 1 BASE. Until a rally emerges from such a base, it cannot be considered one formed as yet.

Lets increase our understanding of this. DIXON in the chart above fell nearly 50 percent at the start of 2023. Within 6 months it regained ground and later took barely 45 days to reach its previous high level. The bottom as captured in the box shows what a compelling base looks like. Finding its extremes between two earnings, you will observe how ferociously the market rallied once it came out of this zone

STAGE 2 UPTREND 'Rally'

Usually triggered by positive news- in this case earnings, all moving averages slope up and volume based buying takes place. This is the best stage to take momentum trades. Either at the start of this phase or the first few pullbacks. The 3rd pullback onwards we starting seeing topping signs. If the stock is slated to be a multibagger, a meta uptrend might consist of a few micro bases as well. The higher 'lows' being printed are characteristic of such a stock. When the usual analysts comment "buy dips", they are actually referring to buying dips when the stock is rallying like this.

STAGE 3 BASE 'Tops'

Any stock rallying can't go up forever. The way the market is that it usually goes sideways for a while, failing to sustain a high and forming a range/base of sorts. Whilst late-comers, usually retail investors are enthusiastically awaiting newer highs, the market tops out. The leg from the last pullback doesn’t create a new push, instead lethargic ranging action leads to a crack of the lows. In the shaded area above, you can clearly see a red bar tail at the highs indicating this and a subsequent break coming. A top is confirmed only when the lows of the range get violated.

STAGE 4 DOWNTREND 'Decline'

The market cracking leads to sharp selloffs followed by rallies to declining moving averages/previous support levels- only to be sold again in to. Fundamentally, this is where one should start monitoring a stock to figure the halts. A fresh Stage 1 will form at a prior support level.

Putting it together

You must wonder whether stage 4 brings the stock down all the way. That’s not true actually. You will see that prior stage 2 uptrends create significant memory points aka pivots at which prices start seeing bounces. If the bounces sustain a couple of times, basing action begins. The illustrated example throws more clarity. We can observe that the stage 4 decline eventually leads to a juicy stage 1 base. This zone cannot be immediately picked but at its eventual turn into a rally, you know a firm low would have been established.

For our style of entries, we’re only looking to milk stage 1s turning into stage 2. The alternate entries are at early pullbacks of stage 2. If you can identify this correctly, you will win half the battle.