MarketsmithIndia Articles

Stock Market Misconceptions

May 23 2020
We are familiar with basic terminologies such as the bull market, bear market, and correction. In simple terms, a “bull market” is when the market moves higher and a “bear market” is when the market moves lower. However, one needs to understand that a new follow-through day and short-term uptrend do not necessarily signal a bull market. Similarly, short-term downtrend does not necessarily indicate a new bear market. These are common stock market misconceptions.

Bear market versus interim correction

Interim corrections can occur even within an upward trending bull market. This is when the major indices cool off a bit. The indices will consolidate for a few weeks or months, before resuming their up move. This phase of consolidation is what we call “interim correction.” The depths of these short-term corrections vary; it can be about 5%, 10%, or 15%. These interim corrections will be mild, not enough to change the underlying bull market.
As a rule, a decline of less than 20% indicates an interim correction. However, if the indices fall 20% or more, then it is a bear market. In the bear market, stock prices decline and investor confidence is low. Although the length of the correction varies, bear markets typically last for a few months.
Interim corrections usually last from a few weeks to a few months. Bear markets are generally triggered by underlying weakness in the economic conditions or by a global or country-specific slowdown. The market, however, may or may not recover quickly from the bear market and cover up its losses. If it doesn’t, then it becomes what is called a prolonged bear market. In a prolonged bear market, which may last for more than 2–3 years, general market sentiment is of despondency with only small intervals of upward rallies.

How CANSLIM can help investors through market turns

CANSLIM is a systematic approach, which can tell you when to be aggressive in a market where risks are low and rewards are high, as well as warn you to cut your position size when the risk-reward ratio contorts. When the market is in a bull run, the market status reflected by the CANSLIM methodology would be a “Confirmed Uptrend”.
Further “follow-through days” during a Confirmed Uptrend signify the strength of the market and will be an opportunity for you further increase your exposure and multiply your gains. However, more importantly, when the market strength fizzles out, the status tracked according to CANSLIM (using distribution days) will also start degrading and will turn into a “Downtrend.”
Steering clear of these stock market misconceptions will help investors in understanding the market better and consequently book greater profits.

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