Profiting from market cycles

By Dominic Picarda, 17 March 2011

The aim of trading is to get in and out of the market at the best possible moments. The odd thing is, though, that most traders try and time their buying and selling by looking at price alone. They pay no attention to time itself. To give myself an edge, I've always tried to combine the two. And the main approach I use for timing the markets is cycles-analysis.

I must admit a lot of people find the idea that there are cycles in financial markets a bit confusing. But there really isn't much mystery about it at all. A cycle is merely a tendency for a market to form highs and lows at a regular interval. This doesn't mean it happens every single time - and nor do we need it to for us to make money from it.

I often discuss the 87-day - or 17-week cycle - when I'm writing about the stock market. As you see from the accompanying chart, this cycle has picked many of the most important highs and lows that have happened on Wall Street over the last three years.

Wall Street's Rhythm

But this is just one of the many cycles at work in just this one market. There is also a 10-year cycle, a 40-month cycle, and a 14-day cycle, to name just a few. The challenge for us is to pick out these patterns and to work out which are the most important in our own trading or investment strategies.

For example, you may be a short-term trader, in which case you may be most keen to follow that 14-day cycle. You may also look at those other longer cycles, because they may determine the larger trend of the market. But since you're hoping to capture swings lasting a few days, your main focus will be the cycle that best explains those swings.

I should point out that it is not correct to say that any cycle makes the market to rise or fall. Cycles merely describe the interval at which the markets rise and fall. In other words, they are an effect rather than a cause. Something else drives the market's movements.

I have to say I am not completely sure why market cycles exist. My preferred explanation would be that they relate to economic factors. The 40-month cycle in the stock market - for example - could be a reflection of a business-inventory cycle of around the same duration. There are plenty of other possibilities. Some cycles-analysts even believe the cause is planetary, although I am not one of them.

Personally, I am not too worried about what causes cycles to occur. The fact that they occur and that I can identify them is good enough for me. The whole point of technical analysis - of which cycles is a part - is to follow the price movements without necessarily having to understand the forces behind them.

It's partly because of my interpretation of the cycles that I haven't given up on the prospects for an ongoing bull market in equities. I'll be discussing some of these patterns in the next edition of the Trader's Weekly Perspective. You can download the most recent edition of this - which includes comments on the main patterns in gold, the US dollar and on Wall Street - from http://bit.ly/e44FSD.

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