Traders today have a monumental task. Never before hasthere been so much volatility in the markets as we see today. Because of thisreality, greater precision in market timing is a strong prerequisite tocompete, survive and profit in these markets.
For speculators, those considered"short-term" traders as opposed to investors (longer-term), precisetiming is imperative. Only those able to achieve effective timing with strictdiscipline (emotional control) will emerge victorious.
Trading well requires that you be able to do severalthings well. All things required can be summed up into 3 main requirements:
1. Discipline (emotional component)
2. Money Management (financial component)
3. Market Timing (analytical component)
It is the 3rd listed component above that this articlefocuses on. And since there are many different ways to time the markets, it isthe one that I find the most valuable that will be addressed here：cycles.
For many traders, the subject of cycles is greatlymisunderstood. The reason for this is that the most common cycle analysistaught by trading instructors is that of the 'fixed-length' variety.
What are 'fixed-length' cycles? Well, in reality, acycle is 'technically-fixed' at some interval, whether it be 10 days, 30 weeks,90 minutes or 900Mhz (900 million cycles-per-second).
Most traders are taught to count the bars from one topto the next, or one bottom to the next, and note if it repeats. If it appearsto repeat, then the trader will use that information to anticipate the next topor bottom, and hopefully the next.
The trouble with this approach, which is commonlytaught, is that as soon as you find a repeating 'fixed-interval', it changesand can result in poor timing and trading losses. This is why when most tradershear about 'cycles', they picture how unreliable this type of analysis is andmay not want to deal with it.
But that would be unfortunate. This is because allprice patterns are the result of cycles. Most traders, even those whoconsciously do not want anything to do with cycles, find indicators such as theStochastic, the RSI, the MACD and moving averages to be useful. In essence,these indicators often expose the dominant cycle for the period analyzed.
Figure 1 above is a Stochastic oscillator, a verypopular analytical tool among traders. Notice how this indicator swings fromtop to bottom to top and so forth. It is clearly a cycle pattern, produced bythe price action of the market analyzed.
If you note that market making bottom when thisindicator makes bottom, and make top when the market makes top, you can withsome minor degree anticipate when the next bottom or top will occur. Yes, itisn't very accurate and precise, but it beats guessing and with experience youcan get close and sometimes nail the turn.
The point of this discussion up to now is to bring youto the logical conclusion that, if market patterns are the result of underlyingcycles, then it makes sense to use cycles to time the market.
Earlier in the discussion I brought up 'fixed-length'cycle analysis and how unreliable it can be. The reason it is unreliable isthat every market pattern is not made up of just one 'fixed-length' cycle, butseveral 'fixed-length' cycles.
Imagine you had a rubber ball that when thrown to theground would bounce and keep bouncing, never losing its height or distance perbounce. It would look something like this...
Now suppose you had another ball and you bounced it twiceas high as the first one.
With the increase in height we also see an increase indistance between each new bottom and top. Now suppose that along the path ofthe bounce you were to mark how high it was from the ground in inches. In thefirst example, let's say the height of each bounce is 36 inches (3 feet). Andthe second bounce example we'll say each bounce is 72 inches (6 feet). If youwere able to combine these two bounces together, what might the resultingbounce look like?
Figure 2 shows a rough draft of what it would looklike. The dotted line is the resulting pattern from adding two patterns ofdifferent height and distance. In cycle-terms, we would refer this as twocycles of different frequency (cycles-per-second) combined to form a 'distorted'pattern. The resulting pattern would not look like any of its individual cyclecomponents, but would have a pattern of its own.
In this example, we only added two different cyclepatterns to arrive at our final distorted pattern. In the markets, pricepatterns are the result of more than just 2 cycle patterns combined, butseveral. This is because there are several external influences affecting themarkets.
There are many external influences that occur withregular intervals. For example, every year there are 4 seasons. Every 24 hoursthere is day and night. For some commodities, there is the planting, thegrowing, and the harvesting intervals. For other commodities there is thebirthing, the fattening, and the slaughtering. And for virtually everything,there is the accumulation and the distribution periods, the supply and demandperiods.
With all different kinds of cyclic influences, it isno wonder that our price patterns look like this...
As you can see in Figure 3, there is clear evidencethat cycles exist in market patterns. And in addition, note that the intervalsare not exact but vary. If we were dealing with one cycle, these intervalswould all be the same in distance. But with several cycles of various wave-lengthscombined, we get price patterns that produce tops and bottoms at varyingdistances in time. Thus, fixed-length cycle timing is not very reliable, but ifone could determine the varying distances based on the fixed-length cyclecomponents that make up the pattern, that would be valuable.
Cycle extraction is a process that most would find noenjoyment in attempting. I have created powerful software programs that help metime the markets with dynamic cycles, and this is what is provided to myclients/members each week. But there are some simple techniques you may finduseful in determining these points for yourself, and that is by using Fibonacciratios.
For example, refer again to Figure 3.
Note the first bottom-to-bottom pattern of 11 bars. Ifyou multiply 11 by .618, you get 6.8. Round that up to get 7 bars and that isthe next bottom-to-bottom pattern you see on this chart.
Note the top-to-top pattern of 9 bars. Multiply 9 by.618 and you get 5.56. Round to 6 and you get the distance of the next top-to-toppattern.
Multiply the next top-to-top pattern of 6 bars by .618and you get 3.7. Round to 4 and you get the next top-to-top distance in thissequence.
Of course if you kept doing this there would soon beno visible top-to-top or bottom-to-bottom patterns as the values would just getsmaller and smaller. So it should be understood that this method of usingFibonacci has its limits like most other indicators.
Also, you cannot expect exact results. For example,the 7 bar bottom-to-bottom multiplied by .618 equals 4.3. Normally roundedwould be 4 and not 5. Yet, the next bottom-to-bottom is 5 bars and not 4. Thelesson here is that you cannot expect to see the next top or bottom occuralways on the exact calculated bar, but at times a bar off. That is acceptablefor market timing purposes I'm sure you would agree.
And note the bottom-to-bottom 11 bars pattern at thevery top of Figure 3. Before that it was 6 bars, and multiplied by 1.618 equals9.7 (rounded to 10) and not 11. But again, 10 is just one bar difference andacceptable.
So while this is not perfect, it is one technique thatcan be used for simple cycle trade timing when applied with proper disciplineand money management.
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