To trade any market successfully, you have to first understand that all markets go through four basic stages. When you understand these four market stages, you will know what to do in relation to what’s happening in the markets.
Understanding this market cycle will tell you if you should be trading long, short, trends, consolidations, or just staying in cash.
Once you understand this, you will have a better idea of when to apply your available trading systems in accordance with what’s happening in the market. You will stop forcing the market to fit into your trading system.
While initially it might take you awhile to recognize which stage the market is in, after some practice and visual experience you will automatically come to understand what to do in the current moment. You will know what to do NOW, not yesterday or tomorrow.
Markets will go through these four basic stages in all time frames, so look carefully at the next picture, OK?
Too simple? Well, simple is good. 
Stage One
Stage one is where the markets have recently been through an extended downtrend. The market has start to consolidate and trade sideways, forming a base. At this point, you might experience erratic, choppy markets to low volatility, sideways drifting markets.
The majority of the sellers are either closing out their positions, or already out of the market. Buyers are starting to gain control of prices.
During this time, as a trader you have to be very nimble to jump in and out of the market. It’s difficult to trade as trends tend to be short, abrupt, and reverse at any support or resistance levels. This is where most traders, after making their money from the trend, give everything back to the market as their trending systems fail to work consistently.
Stage Two
After consolidating and chopping around in Stage One, prices break out to the upside. Many traders don’t expect it, because they have been “lulled asleep” by the sideways action of the market. Those trading reversals from Support and Resistance levels get stopped out because Resistance Levels just got blasted through!
Because people tend to remember more recent events, nobody believes that the market has started out on an uptrend. But this is where the majority of money is made. As traders continue selling into the market expecting it to go back down, it keeps going up!
Here, the trend reversal systems that work so well in sideways markets start failing horribly. And those who trade these systems start to give back all the money they made earlier in Stage One.
Stage Three
By now, the markets have been on a prolonged uptrend. Everybody can see it, and everybody’s rushing in now. It’s everywhere in the papers, on the news, and it’s the talk on the street! But alas….
The markets start to move into sideways again. This is where the traders who have ridden the big trend from the beginning are now selling out to the novice traders coming late to the party. Here, because the markets have been trending for so long, novice traders start using trending systems to trade.
But guess what? Markets are no longer trending!
As the buyers and sellers start moving into equilibrium, the markets go into consolidation. As buyers close out their positions, and sellers start taking back control, the markets become choppy, volatile and abrupt again. It seems as if a lot of churning is going on as the big boys start switching sides from the long to the short.
During this time, the markets can also start to drift into quiet markets again. The big boys are already out of their long positions, are already short the market, or waiting to start selling again. By now, the novice traders who are employing trending systems are crying their hearts out because their systems don’t work, and they are losing money on a consistent basis.
Stage Four
That’s right… markets start to breakout into a downtrend from here. And again, novice traders are caught because they don’t believe the party is over. When the downtrend starts, it first looks like a correction or retracement before the uptrend will resume. But after the first bounce, markets don’t make a new high.
In fact, they break through previous support levels and start into the next prolonged trend. This time, instead of moving up, prices are moving down. And those traders still long, or getting in long are now punished as markets move down… down… down…
The Smart Trader
Once you understand that all markets go through these cycles on all time frames, you become a smarter trader. You won’t be so easily caught out when markets move to the next stage, and even if you are wrong initially you can quickly adjust and get back on track.
Here is an example of these four stages happening in the market, on a weekly chart of the EURUSD.
Remember, markets go through these four market stages on all time frames from monthly all the way down to the 5 min charts.
Generally, when markets are chopping and consolidating, you either stay in cash or employ reversal trading systems. When markets are trending, you either trade in the direction of the trend or stay in cash. In other words:
- Stage One: Consolidation after a long downtrend.
- Stay in cash, or
- Trade reversal systems.
- Stage Two: Markets have broken out to the upside.
- Trade with the uptrend, or
- Stay in cash.
- Stage Three: Consolidation after a long uptrend.
- Stay in cash, or
- Trade reversal systems.
- Stage Four: Markets have broken out to the downside.
- Trade with the downtrend, or
- Stay in cash.
Summary of Market Stages
There you have it. It’s quite elegant in its simplicity, and when you understand this you can improve your trading tremendously.
When you know what stage the market is in, you can then trade with more confidence and ease.
Which in turn, makes you a Smarter Trader.