What is a Rally?
A rally is a period of hours, days, weeks, months, or sometimes years during which securities prices consistently rise.
How Does a Rally Work?
Identifying and measuring rallies is both art and science. Of course, different sectors may experience rallies at different times.
The causes and characteristics of rallies vary, but most financial theorists agree that economic cycles and investor sentiment both play a role in the creation and momentum of rallies. In general, information about a strong or strengthening economy, indicated by high employment, high disposable income, low inflation and high business profits usually ushers in a rally. The existence of several new trading highs for well-known companies also indicates a rally is occurring. It is important to that government involvement affects rallies: Changing the federal funds rate or tax rates indirectly encourages economic expansion or contraction.
Rising investor confidence also indicates a rally, and it is perhaps more powerful than any economic indicator because when investors believe something is going to happen (a rally, for example), they tend to take action (purchasing in order to from expected price increases) that actually turn expectations into reality. Although it is an objective concept, investor sentiment shows through in mathematical measurements such as the put/call ratio, the advance/decline line, IPO activity, and the amount of outstanding margin debt.
As investors take profits or react to bad news or negative indicators, rallies generally unravel over time.
Why Does a Rally Matter?
Rallies usually present a multitude of moneymaking opportunities for investors because prices are generally rising across the board. But rallies don’t last forever, and they don’t always give advance notice of their arrival, so the investor must know when to buy and when to sell to maximize his or her profits. This means the investor must attempt to "time the " or gauge when a rally has begun and when it is ending.
Analysts spend thousands of hours trying to mathematically determine what trigger the next rally and how long it last. Technical analysis is especially prevalent in this effort, although less sophisticated indicators such as hemline fashions or the NFL division of the latest Super Bowl winner also provide fodder for such predictions. This in turn can sometimes lead to speculation that a rally is just around the corner, which can then become a self-fulfilling prophecy.