The market doesn't go up in a straight line. At some point the advance begins to sputter and leading stocks roll over. Shrewd traders sell to lock in profits, shorts spring into action, and a downtrend unfolds. Amateurs try to catch a bottom but sellers don't let up easily. As selling intensifies, more latecomers decide to sell to save whatever profit they may have left. Bargain hunters who have doubled down run out of cash and/or conviction. As pain becomes unbearable, the last unlucky longs sell in disgust. The market hits bottom.
That's when most people are finally convinced the market is poised for a major decline or are hurting so badly that they are not in a condition to buy. But no one is selling. The market fails to take out the recent low. A new leg up starts. That's when the best buying opportunities present themselves - if you know where to look.
Most people go after former leaders that are now selling at a discount, determined to make up for the lost opportunity of the previous cycle. While it is true that some big leaders will form several bases on the way up, every new advance also produces a new batch of leaders. Those are the stocks that were quietly forming bases during the previous market advances when everybody's attention was elsewhere. Now they are finally ripe for a breakout. But a combination of post-correction pessimism and the fact that these names are new and unfamiliar makes these breakouts go virtually unnoticed. Shrewd traders refer to these stocks as undiscovered. These are your best candidates - not the old recycled stuff with 200 daily messages on Yahoo about how great they are.
As more breakouts occur, the market begins to advance in earnest. But most investors are still cautious because they are not convinced that the worst is over. They buy small amounts timidly with the intention to add later. As the advance becomes apparent to more and more people (including - surprise! - institutions), with the early breakouts showing 20-40% gains, more investors become convinced that it is finally "safe" to re-enter the market and start buying stocks that have "proven themselves" - the new darlings that are up a lot.
The lesson here is that your actions must be counterintuitive. First, you must discipline yourself to sell early and stay out for the duration of the correction. This way you will be unscathed and ready for action when the market turns. Second, you should deploy the majority of your capital early on. You may encounter some turbulence as the market shakes off the last bears but all you have to do later on is just sit back and watch your account grow.
Every trader's dream is to catch a tenbagger early on. But there is no way of knowing how far a breakout will go or whether it will succeed at all. Instead of trying to deduce your best pick, let the market do the sorting out for you. Buy as many breakouts early on as you can and watch them. Sell your laggards to add to your winners.
As yet more investors are drawn into the advance, institutions and stock operators begin to push junk out the door by orchestrating breakouts and issuing upgrades. If in the beginning stocks with top-notch fundamentals can barely lift themselves out of long bases, the end of the advance is usually characterized by excessive gap ups of so-so stocks out of odd shaped short bases on huge volume. That's when the public finally throws caution to the wind and starts buying indiscriminately: "What the heck - everything is going up anyway!" The institutions are only happy to oblige by selling into the strength as they need volume to unwind large positions.
This euphoric action should raise red flags. Just like in the beginning you have to force yourself to enter the market, in the end you must resist the temptation to chase late breakouts or pyramid, and should start parting with at least some of the market darlings that "have been so good" to you.
Eventually the music stops but the public that took so long to get into the market is now reluctant to leave, and the cycle repeats itself.
