A stock market rally is an exciting thing to be part of. All week you’ve been watching your holdings decrease in value – then, suddenly, they’re trending up at a fast pace! A market rally can ease the pain of sudden losses and even end higher than where the downturn started. That is, of course, if it’s not a dead cat bounce or a pump-and-dump scenario. 

In times of market volatility, stock market rallies aren’t uncommon. In fact, they’re actually part of the reason markets are so volatile! It’s important to pay attention to when the market is poised to rally and how to act when the needle ticks up. If there was a stock market rally today, would you recognize it? Do you have a plan to capitalize on it?

What Is a Stock Market Rally?

What market rallies mean varies, but they generally indicate an upswing in the markets after a period of downturn. Let’s look at a common scenario we’ve seen all too often lately. 

The market opens Monday at a loss, setting the tone for a rough week to come. Stocks trend lower Tuesday and Wednesday on poor economic news, and are flat on Thursday. The market is down 8% heading into Friday. Then, everything goes in reverse. Stocks climb on good earnings reports and positive news; sectors that have performed poorly all week are up. Friday’s gains amount to 6%, leaving the week down only 2%. 

Stock market rallies are sudden upswings that reverse a downtrend, usually over a day or two. Rallies happen in both bull and bear markets. A bull market rally is a rally that continues to lead to growth beyond the duration of the rally itself. Conversely, a bear market rally is part of a long-term downtrend.

Why Does the Market Rally?

The market can rally for many reasons. In bull markets, rallies often come on the heels of good news or expectations. For example, if there are a series of earnings calls in the upcoming week and major companies expect positive earnings, the market might preemptively rise. Likewise, in a bear market, a hint of good news might be exactly what investors need to hear to restore their confidence in the market. 

Rallies can also occur as investors strategically open and close positions. Let’s say you want to invest in Square (NYSE: SQ), but haven’t pulled the trigger because you felt the valuation was too high. Then, a down market took the share price from $80 down to $60 – a much more reasonable valuation in your mind. You decide to invest at this price point and put new money into the market. As millions of other investors do the same, the market rallies!

It’s the same for dollar-cost averaging. If your entry point for Coca-Cola (NYSE: KO) was $55 last year and the share price is at $45 today, you might decide to add to your position as a way to average down. Again, if enough investors take this mindset, the market rallies up.

Why Do They End?

While bull market rallies tend to result in continued growth, a bear market rally is apt to trend down again. This happens for the same reason rallies begin. Instead of buying at a discounted rate, sellers get out of positions that have hemorrhaged value. The small spike from a rally is their opportunity to sell at less of a loss (or even a gain). Unfortunately, as millions of sellers unload their unwanted securities, it pushes the market back down again, ending the rally. 

Will the Market Rally Today? Tomorrow? Next Week?

You can never tell exactly when the market will rally. Usually there’s a catalyst that triggers the rally – either a technical metric, news or the volatility of the market. Rallies are more likely to occur in bear markets than bull markets, and the duration of a rally is usually short-lived. 

The best way to capitalize on a bear market is to keep cash on the sidelines and be smart with your positions. Find value plays and buy into them when the market is depressed, and with any luck, you’ll catch the wave of a stock market rally. Trim your underperforming securities on the upswing – but only if your investment thesis has changed and you no longer see the same value proposition from that company. 

As the current markets rise and fall with relative unpredictability, we’re bound to see a few more rallies over the next few weeks and months. Remember that rallies are short-lived and opportunistic moments – not indicative of long-term trends. Keep a level head and you’ll make smart investment decisions during the next one.