Understanding the Cycle: and why big money wins and the small guy gets crushed.
What is the cycle? The cycle I am referring to is the investment cycle. To be a successful investor you must understand the investment cycle. In my time as an investor understanding the investment cycle of a stock may be one of the most important lessons that I've learned. Let me be clear, I'm not talking about cyclical stocks. I'm talking about the investment cycle. To understand the cycle is to understand when and where large professional investors purchase stocks, when and where small and unprofessional investors purchase there stocks, when and where the media covers that stock, when and where the professionals sell their stock, and when and where the small investors end up selling their stock. Being on the wrong side of the cycle is why many new investors lose money. It's also why many people have a skepticism about the stock market. I want to attempt to demystify the stock market by discussing the cycle and hopefully add a coin to your investing knowledge bank.
First and foremost, there is nothing illegal about the cycle. The cycle is like an open secret that the professional investors, sometimes called "smart money" or "strong hands" uses to pry money away from the novice investor or small investor like you and me, sometimes referred to as "dumb money" or "weak hands."
So how does the cycle work? The cycle works in eight stages.
Stage one, a stock finds a price level that it trades at for a period of time. At times the price level is a level below the stocks last high.
Stage two, the smart money begins to accumulate the stock at the lower price level believing the stock is undervalued.
Stage three, as more smart money piles into the stock, the stock price rises, surpassing it's old high.
Stage four, the stock makes a new high, and this attracts media attention. The media will showcase the stock and its recent run.
Stage five, the dumb money, the small investor sees the media attention given to the stock and feels the stock is a buy, because the stock is going up and is in the news.
Stage six, the smart money sells their shares to the dumb money.
Stage seven, the stock prices falls, leaving many small investors with a stock that is down from where they purchased it.
Stage eight, after weeks of looking at the loser in their portfolio, dumb money sells the stock at a loss, convinced that the market is rigged.
Here are the stages on a chart of Apple
1. The stock after the pull back.
2. The accumulation by the smart money.
3. More smart money piles into the stock.
4. After a rise from $75 to $125 the stock is covered by investment news.
5. The small investor buys at $125 hoping for another 50 point move.
6. The smart money is selling their shares at $125.
7. The stock has fallen from its $125 high, the smart money is out.
8. The small investor sells his stock at $100, losing $25 for each share of stock they own.
From the chart above you can see that the eight stages occurred over two years. The smart money doesn't rush, patience is their ally. The smart money will wait for the right time to buy and the right time to sell, buying when the stock is undervalued, and selling when the stock is overvalued.
New investors, the novices, the dumb money are short on patience, and buy on their fear of missing out. New investors want to be a part of the move more than they want to wait for the right price. Seeing a stock increasing in price on our T.V. is so enticing. It's easy to see the money instead of the loss, to convince ourselves that the right time is now, and the right price is the current price. It's a habit that must be broken in order to succeed as investor.
Now you may be wondering whose side is the media on. Is the media covering the stock at the top to help the smart money unload their shares? The answer is no, the media is on their own side. The media is there to for entertainment purposes. When our favorite investment news source covers a stock that has gone up 25% in three months, it's not to entice investors to go out and buy the stock, its to entertain. Unfortunately many new investors being undereducated to how the markets work, take this piece of entertainment as a buy signal, which should never be done.
I have a number of losses from my early days investing because I took what I read and heard as gospel, and bough stocks at the top only to sell them later at a loss. The Seville Report was started to help the inexperienced investor get educated and understand value, and to help separate real analysis from entertainment. The Seville Report looks to find stocks that are in the stage before accumulation by smart money. This is where the risk is very low, but the potential reward is very high.
So the next time you see the investment media covering a high-flying stock, before you run to your computer to buy it take a moment and think, where in the cycle is the stock? Is smart money getting in or out? Hopefully asking your self these questions can keep you on the profitable side of the cycle.
I hope this article provides you with value that you can apply to your investing.