Tips on Technicals - Cycles
| Indicator type: |
Defines timing of highs and lows in a market |
| Used to: |
Increase probability of buying lows and selling highs |
| Markets: |
All cash and futures, not options |
| Works Best: |
All time frames in combination. Aligning long and short-term cycles increases probability of catching the bulk of market moves. |
| Formula: |
Measure cycles from bottom to bottom subjectively. A cycle is often defined by a range instead of a single number (example 3.5 - 4.5 years) |
| Parameters: |
Market and time frame dependent. Most markets can have 4 year cycles as well as shorter cycles denoted in months, days and hours. |
| Theory: |
Cycle analysis attempts to find recurring major and minor peaks and troughs in price movement for better trade timing. By adding short, medium and long-term cycles together the actual price activity can be forecast.
In a trading range, cycles are fairly regular in that the market peaks half way through the cycle. However, when a market is trending, the cycle peak tends to shift left or right depending on the direction of the larger trend (called left or right translation). This is consistent with the notion that in rising markets, prices should spend more time going up and in falling markets, prices should spend more time going down.
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| Interpretation: |
A cycle is simply a regularly occurring sequence of events. The sun rising every morning and setting in the evening is a cycle. The four seasons are one cycle. In financial and commodity markets, a cycle is loosely defined as price movement of a market from a local bottom to a local top and back again. For example, if a market is in a 10 point trading range with a bottom of 40 and a top of 50, the price movement from 40 to 50 and back to 40 again is one cycle. Traders can use this information to enter low risk buys at 40 and low risk sells at 50. |
The US Treasury bond continuous futures contract showed very clear cyclical behavior in the mid-1980's (figure 1). From the major low in mid-1984 to the major low in 1987, both marked with "B," we can deduce a roughly three year cycle1. Within the long-term cycle, there is a medium-term cycle of about eight months. Each of these minor cycle bottoms is market with a "b." Adding the two cycles together defines the likely trading activity in the market. A shorter term chart would also show daily and intraday cycles to further refine the market forecast.
In trending markets, such as in figure 1, the intermediate cycle tops and bottoms provided good places to take profits ahead of each intermediate correction. Conversely, when the major cycle was in a declining phase, the minor cycle bottoms provided good places to take profits from short positions.
In a flat market, such as the period from October 1993 to February of 1994 (figure 2), the daily chart shows a three week cycle. Each cycle bottom occurred on or near support at 113. Buying at the cycle low and selling one and one half weeks later proved to be a successful low risk strategy. The cycle peaks were in the middle of the cycle since the larger market trend was flat. Note that the late January cycle bottom never really made it to the support line which reinforces the need to use several technical indicators for trading.
1 Of course, one pair of major lows does not define a market's cycles. Here a longer-term chart does confirm a slightly longer than three year cycle.
