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The 4-stage market cycle is a reliable tool that allows position traders to spot major market moves.

Here we depict and explain the basic market/stock cycle and 5 winning scenarios derived from it. We also include brief comments on how short sellers can profit from them.

• The basic market/stock cycle.

• Scenario 1: The double top.

• Scenario 2: The triple top.

• Scenario 3: The head and shoulders.

• Scenario 4: The multi-leg fiasco.

• Scenario 5: The downtrend resumption.

The basic market/stock cycle.

Stage 1 represents the cycle's valley. People talk about a stock in Stage 1 as "basing". After a protracted base at low prices, the collective mindset is hopelessness. Better market conditions, company growth, or good news will encourage buyers to step in and pay higher prices. Then, the price breaks out of its base and initiate an uptrend, or Stage 2. The collective mindset –greed, then euphoria– creates more and demand, which drives the stock higher. When buyers refuse to continue paying higher prices and sellers press the price down when it rises, prices move sideways into a Stage 3, where indecision is the collective sentiment. At some point, the selling pressure increases and the stocks enters into a downtrend, into a Stage 4. In Stage 4, fear, then panic, force investors to unload their long positions. Stage 4 is the entertainment park for happy short sellers trying to capitalize on the downtrend. Skilled short sellers will sell the stock at a high price (Stage 3 or early Stage 4), buy it back at a lower price and pocket the difference as profit. This is the most basic winning scenario, where Stage 3 is the classical "round top" or "V-top" reversal.

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Winning scenario 1. The double top.

This is a bearish pattern that, when completed, looks like an "M". When a stock is in an uptrend, it may hit a top (red line, resistance), pull back (a) to a previous key support level (green line), and then resume its uptrend (b). If buyers refuse to pay higher prices when it reaches the resistance established by the first peak (c) the price will likely start retracing to the support area (green line). If the prices fall below the support level a sustained downtrend is expected. Short sellers can initiate a short position once the support is violated (x).

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Winning scenario 2. The triple top. 

This is a rare, but very powerful, bearish pattern derived from the double top formation. When a stock is in an uptrend, it may hit a top (red line, resistance), pull back (a) to a previous key support level (green line), and then resume its uptrend (b). If buyers refuse to pay higher prices when it reaches the resistance established by the first peak (c) the price will likely start retracing to the support area (d). In the triple top, the cycle repeats itself once more. Short sellers may initiate a short position when the resistance is confirmed by the third peak (e), but it is technically safer to initiate, or add to, a short position after the price breaks previous support levels (x).

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Winning scenario 3. The head and shoulders reversal formation.

This is a frequent, extremely powerful, easy-to-spot, bearish pattern similar to the triple top. When a stock is in an uptrend, it may hit a top (red line, resistance), pull back (a) to a previous key support level (also called the "neckline"), and then resume its uptrend. Buyers may pay higher prices, even above previous resistance levels (c), but only for a short period, after which sellers take control over the stock price, retracing it to the support area (d). If buyers refuse to pay higher prices when it reaches the resistance established by the first peak (e), a head and shoulders reversal is completed. Short sellers may initiate a short position when the resistance is confirmed by the third peak (e) or when the price breaks the neckline (x). 

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Winning scenario 4. The multi-leg fiasco.

Often seen in market "bubbles", "hot" stocks, and "pump and dump" plays, when properly timed, this pattern may be extremely profitable for short sellers. A protracted base is interrupted by a sharp price increase (a) followed by a moderate retracement and consolidation in a higher trading range (b). The leg-consolidation structure repeats itself 2-4 times, due to greed cycles, "hot" news and, presumably, low-volume short squeezes. Once the stock reaches outrageously overbought conditions, market indecision arises as a classical triangle consolidation pattern (c), indicating an imminent return to fair valuation. A bull trap, in the form of a sharp spike at the end of the consolidation (d), may or may not be present. Short sellers can initiate a short position during the bull trap, however it's technically safer to establish a short position once the previous consolidation’s support is violated (x).

Growth companies may exhibit a leg-consolidation-leg pattern that is bullish in nature and may continue as a long-term uptrend. Low-performance companies cannot support sustained uptrends, thus creating a multi-leg fiasco.

This pattern's existence is speculated by our own research, and has not been confirmed by external sources. We have reasons to believe that this pattern is real and repeatable.

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Winning scenario 5. The downtrend resumption.

In a Stage-4 stock, the downtrend (4) may be interrupted by bullish retracements and pauses, often associated to market's bullish conditions or random good news. Those interruptions may show themselves as bullish spikes (a), flat consolidations/pennants (b) or short triangle consolidations (c). If the reasons leading to the major downtrend persist, short sellers can safely establish or add to a short position each time the downtrend is resumed (x).

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