Differentiate correction from cycle
Fluctuation in price of a stock is a common phenomenon. This fluctuation can be in an uptrend or downtrend. Whenever there is a change in price it is not a change in trend or cycle, but it is a correction.
Change in trend of a cycle is often confused with correction. The price movement could be in an upward trend but still there would be a fall in price which is aptly termed as correction. Correction is a part of the price movement.
Before buying a stock, we need to know whether it is in uptrend or downtrend. A trader needs to identify whether the change in price is a correction or a change in cycle.
Trending stock has cyclical changes. Every fall in price is not indicative of trend reversal. It is very important for a trader to understand trending in short term. In a cyclical change the speed and intensity of price movement would be very different.
If a trader is willing to know whether the price is moving upwards or downwards what he needs to see is the change in cycle of a price rather than the movement of the price.
To understand this concept more aptly let us consider an example. If we consider weather conditions, we have seasons like summer, rainy season and winter. There may be unseasonal rains in summer but that does not imply the onset of monsoon.
The unseasonal rain may be considered as a correction and the change in season is a cycle. Similarly, every stock goes through ups and downs and there is a change in the cycle for various other reasons.
Few years back there was a huge demand for IT sector and the stocks of this sector were very much in demand and the prices rose very sharply.
Several companies from the United States preferred outsourcing and there was a huge rise in call centres giving opportunity for many youngsters to find new jobs. Such kind of changes affect the sectoral indices.
Later there was a boom for real estate. After that various scams related to banks were exposed and we have seen merging of many banks. Small banks which were on the verge of closure were taken over by other banks.
For example, merging of State Banks with State Bank of India. To a certain extent scams in the banking sector led to poor performance of banking stocks. All of the above are indicative of cyclical changes.
Whenever there is a correction in stock it could be a price wise correction and time wise correction. When a change in price is in a range for certain period, it is called time wise correction.
When a stock is in correction, it does not fall below its previous low. This is one factor which is indicative of time wise correction. In price wise correction we would notice a sharp fall in the movement of a price.
When there is a change in the trend of a stock and the price continuously falls very sharply then it is price wise correction.
Thus, by differentiating between correction and cycle we can sell the right stocks and enter or exit at the right points and earn profits.
(The author is a homemaker who dabbles in stock market investments in free time)