A business cycle is defined as:
- Expansion: The economy is moving out of recession. Money is cheap to borrow, businesses build up inventories again and consumers start spending. GDP rises, per capita income grows, unemployment declines, and equity markets generally perform well.
- Peak: The expansion phase eventually peaks. Sharp demand leads the cost of goods to soar and suddenly economic indicators stop growing.
- Contraction: Contraction: Economic growth begins to weaken. Companies stop hiring as demand tapers off and then begin laying off staff to reduce expenses.
- Trough: The economy transitions from the contraction phase to the expansion phase. The economy hits rock bottom, paving the way for a recovery.
Knowing where the economy is in the business cycle is key to knowing when to take long and short position in the market.