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Market cycles

A bull run or a bear market means at least a 20% change in the index value. Nobody can accurately predict stock market movements, but they can be explained. Here’s what moves the stock markets.

Print Edition: October 16, 2008

Stock markets move up and down in recurring cycles. A prolonged rise in stock prices is known as a bull run while a consistent decline is called a bear market. These are different from short-lived upward or downward “corrections” in stock prices. Typically, a bull run or a bear market means at least a 20% change in the index value. Nobody can accurately predict stock market movements, but they can be explained. Here’s what moves the stock markets.

BULL MARKETS
Bullishness in the markets can be the result of an economic boom which in turn fuels optimism among investors. The Indian markets witnessed the longest bull run during the past five years (see graph below), a period during which the BSE Sensex gave a spectacular annualised return of almost 47%.

Indicators of a Bull Run
• Rising corporate earnings
• Low inflation
• Low interest rates
• High fund flows and liquidity
• Increased investor interest

Bull phase: 15 May 2003 to 8 Jan 2008
Sensex peak: 20873
Sensex low: 3012
Rise: 592%

BEAR PHASES
Bear phases occur in times of an economic downturn and when there is all-round pessimism. Unlike a correction, a bear market is marked by a consistent fall in stock prices over a long period of time. The Indian markets could slip into a bear phase. Since the beginning of this year, the Sensex has lost almost 50%.

Indicators of a Bear Phase
• Falling corporate earnings
• Rising inflation
High or rising interest rates
• High fund outflows and liquidity crunch
• Low investor interest

Bear market: 14 Feb 2000 to 24 Sep 2001
Sensex peak: 6151
Sensex low: 2627
Decline: 57%

SELLING SHORT
• Bearish markets and falling stock prices don’t always mean losses. You can also profit from falling prices if you use the right strategy and are able to take quick decisions.

• The most common bear market strategy is short selling—or selling shares you do not own in the expectation that the price will fall. When the price falls, you buy back the shares at a lower price.

• Buying back shares to square a position is called short covering. The difference in the price is your profit. Of course, this is a risky gambit and can result in a loss if the price rises after you sell.

• Till April this year, it was necessary to cover short selling during a trading session. You had to compulsorily submit shares you sold by the end of the day. Failure to do so attracted a penalty.

• But the introduction of the Stocks Lending and Borrowing Scheme allows short sellers to borrow shares from brokers and carry forward the transaction for up to one week.

HOW SELLING SHORT WORKS
Suppose you short sell 500 shares of a company at a price of Rs 100 each. You are expecting the price to fall to Rs 85. The table on the right shows your profit (and loss) if the share price falls (or rises). The calculation does not take into account the commission payable to the stock broker on each transaction.

500 shares short sold at Rs 100Scenario I: The share price fallsScenario II: The share price rises
Stock price85110
Difference from your selling price-15+10
What you pay to buy back shares42,50055,000
Your profit (or loss)7,500-5,000
All figures in Rs  

 

KEEP IN MIND
• If you are unable to square short selling, the exchange buys shares in an auction and gives them to the buyer. That can lead to losses if share price is higher.

• Discipline is important. Buy back shares when the target price is reached. Similarly, set a strict target to cut your losses and buy back if the price starts rising.

• Don’t wait till the fag end of the session to buy back. Short covering can push up the price of a share as short sellers scramble to buy back.

• Too much short selling can cause a share to be oversold. that is actually a bullish signal as short covering may cause the price of the share to go up.

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