Understanding Stock Rallies: Definition & What Causes Them

A rally refers to a period of continuous increase in the prices of stocks, indexes or bondsBondsBonds are fixed-income securities that are issued by corporations and governments to raise capital. The bond issuer borrows capital from the bondholder and makes fixed payments to them at a fixed (or variable) interest rate for a specified period.. The word, rally, is typically used as a buzzword by business media outlets such as Bloomberg to describe a period of increasing prices.

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A rally occurs due to several reasons. Short-term rallies are caused by news or events such as a new CEO appointment that affect the demand-supply equilibriumSupply and DemandThe laws of supply and demand are microeconomic concepts that state that in efficient markets, the quantity supplied of a good and quantity. Rallies can also be long-term, which result from changes in macroeconomic factors such as announcements of changes in key interest rates and fiscal policyFiscal PolicyFiscal Policy refers to the budgetary policy of the government, which involves the government controlling its level of spending and tax rates.

The stock market is volatile and known for its constant fluctuations. Even seasoned analysts find it hard to predict the direction of the market. Stock prices can go down suddenly after a long period of increase. The market can also experience a sudden increase in stock prices after a long-term downward trend.

Bear Market Rally

A bear market rally refers to a temporary uptrend in prices during a primary trend bear market. The increase is usually between 10% and 20%. It starts suddenly and does not last long. Notable bear market rallies occurred during the stock market crash in the Dow Jones Industrial AverageDow Jones Industrial Average (DJIA)The Dow Jones Industrial Average (DJIA), also referred to as "Dow Jones” or "the Dow", is one of the most widely-recognized stock market indices. in 1929 all the way to the market bottom in 1932, and in the late 1960s until the early 1970s. It comes in two types:

#1 Short-term bear market rally

This usually lasts from half a day to two days. A short-term bear market rally happens when the stock market experiences several lows within a week or month.

#2 Intermediate-term bear market rally

When the stock market experiences multiple bounces or short-term rallies, they are called an intermediate-term bear market rally.

At first, a bear market rally looks like a good thing as it serves as a respite from an otherwise downward direction of the market. However, it can be risky for investors who buy stocks, thinking that things will improve over time. They may end up losing money when the rallies end and the market resumes its downward spiral.

What to Do During a Market Rally

You can avoid losing money during a market rally, but it entails planning and strategy. Here are some guidelines to consider taking advantage of the upward trend in the market:

Mode of investment

Consider the situation of the market when investing, especially if you’re into equity mutual funds since these investments are significantly affected by the mood of the market. Instead of placing lump sum bets, exercise caution when there’s a bullish market rally.

Asset allocation

Establish a strategy on which asset classes to invest in. As the prices of small- and mid-caps increase and the bets become risky, consider allocating some of your money towards large-cap equity funds, as these may be able to maintain portfolio returns during a market rally.

Manage risk

Higher returns are always a welcome idea, but investors also need to consider the other side of the coin, which is risk management. Many people say, “Don’t put all of your eggs in one basket.” In stocks and investing, it means making your portfolio as diversified as possible, so you can better manage risk.

Related Readings

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To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below:

• 2010 Flash Crash2010 Flash CrashThe 2010 Flash Crash is the market crash that occurred on May 6, 2010. During the 2010 crash, leading US stock indices, including the Dow
• Bullish and BearishBullish and BearishProfessionals in corporate finance regularly refer to markets as being bullish and bearish based on positive or negative price movements.  A bear market is typically considered to exist when there has been a price decline of 20% or more from the peak, and a bull market is considered to be a 20% recovery from a market bottom.
• Relative Strength Index (RSI)Relative Strength Index (RSI)The Relative Strength Index (RSI) is one of the most popular and widely used momentum oscillators. It was originally developed by the famed mechanical engineer turned technical analyst, J. Welles Wilder. The RSI measures both the speed and rate of change in price
• Technical Analysis: A Beginner’s GuideTechnical Analysis - A Beginner's GuideTechnical analysis is a form of investment valuation that analyses past prices to predict future price action. Technical analysts believe that the collective actions of all the participants in the market accurately reflect all relevant information, and therefore, continually assign a fair market value to securities.