There are many popular misconceptions about the understanding of the market cycles. In this post, we discuss a few of them and try to remove the layers of fallacy or common delusions. 

 Assuming a similarity between two cycles  

 Cycles are an overarching concept. Cycles are a recurring phenomenon, but that’s where the similarity ends. It is a common mistake to assume that their duration will be the same or like that of a previous cycle. Also to assume the rise and fall in the number of points will be like previous ones is incorrect. 

Visualizing similarities, drawing patterns, finding parallels, guessing a previous similar trend, could lead to wrong conclusions. Cycles will never have a similarity with any of the previous cycles or situations. They could differ in duration, magnitude, length, the sequence of events, and any other attributes that drive them. 

It thus can be a fatal folly to assume a pattern and draw a conclusion. Also, the drivers of these cycles, such as fundamentals, emotions, and liquidity, are often the same in some proportion or combination, but not identical. 

   

It is possible to time the cycle  

  Because our educational system is so hung up on precision, the art of being good at approximations is insufficiently valued. This impedes conceptual thinking.  

–Ray Dalio 

  

  

Often people try to get it “perfect”. They attempt to buy a stock at the absolute lowest price it hits and sell at the absolute highest price it touches. It is impossible. Cycles are a general trend of stocks being cheap or expensive. 

This means that sometimes companies sell their stocks at a lower price than their actual worth. And sometimes their stock price is higher when compared to their actual worth. As discussed in previous chapters, it is impossible to time the cycle. Even the most intelligent investors have failed in doing so. 

  

Cycles can help foresee the future  

Many people see cycles as a way of predicting the future. However, it’s in fact a recognition of a simple fact that the price of a stock and the value of a stock is not the same thing. Also, there will be a constant fluctuation in between the two. 

When investors are pessimistic, even high-quality stocks with good fundamentals and future potential, sell at a lower price than their actual worth. And when investors are overly greedy and optimistic, even low-quality stocks with bad fundamentals and other defects, sell for a price higher than their actual worth. 

Understanding market cycles is more a mechanism to evaluate a stock’s current worth, value, and quality relative to its price. This helps to determine if it under or overpriced. However, this should not be a means to forecast its future price changes. 

 

A handful of factors can determine cycles  

Cycles result from various events and factors and are not one thing by themselves. They get influenced by a range of factors, from market fundamentals to liquidity, to sentiments. It is hence a mistaken notion to assume that a cycle depends on only one or two factors. 

 

  

“This time it’s different”  

The biggest misconception about cycles is that investors always assume “This time it’s different”. The problem starts at the extreme point of the cycle when a new belief system sets in. In a rising market, they think it will continue to rise and in a falling market, they expect the fall to continue. 

Over the decades many people have made such claims, but it has all been proved wrong. Cycles are a fundamental part of individual markets. No matter what happens, the stock market graph will never be a straight line. 

 

 

 

Downturns are bad  

No part of the cycle is risky for an intelligent investor who understands cycles. Many people think the bearish or the falling phase of an economic cycle is always bad or damaging for an investor. 

This is not always true. If an investor positions himself and his asset allocation based on the market cycle, every point of the cycle provides a fair opportunity for growth and profit. This is regardless of whether prices are rising or falling. 

  

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