Trading Cycles and their Implications

From the good Mr. Brett Steenbarger:

"An Introduction to Trading: Cycles and Their Implications

In the last post in this series, we took a look at the structure of price changes in the stock market. The key idea was that the broad indexes move in aperiodic cycles, with periods of upward and downward trending punctuated with periods of distribution. With this notion of cyclical structure as part of a conceptual framework for trading, it is possible to generate ideas of likely market action based upon: 1) where we are at in the current market cycle and 2) where the current cycle is situated within cycles at longer time frames. As we move forward in this e-book, I'll be providing specific examples of cyclical structures, so that it will be easier for you to recognize them as they are occurring.

This view of market behavior carries a number of implications and helps explain several common market observations:

1) Chart Patterns Make Sense - The literature of technical analysis emphasizes such chart formations as double tops and bottoms, head and shoulders formations, cups-and-handles, etc. All of these naturally follow from a cyclical view of markets in which momentum peaks and valleys tend to precede price peaks and valleys. Similarly, the technical literature is replete with oscillators and ideas about trading divergences in overbought/oversold; RSI; stochastics; MACD; etc. These divergences also make sense within a cyclical view of price change, as markets lose momentum prior to reversing. Even the formulations of Elliott and Gann theorists make sense as ways of conceptualizing phases of momentum within cyclical patterns.

2) No One Strategy Always Wins - Go back to the idealized chart of cyclical price change from the prior post. During the market moves between price lows and momentum highs and between price highs and momentum lows, trend following strategies will tend to work. During periods between momentum highs and price highs and between momentum lows and price lows, we will tend to see countertrend (reversal) strategies working. During the period between price highs and momentum lows, we'll tend to see volatility expand; during the period between momentum highs and price highs, we'll tend to see volatility dry up. Using the same strategy across all phases of market cycles will result in periods of uneven performance.

3) No Two Cycles Are Identical - Cycles are nested within cycles; as a rule, the larger the time frame, the larger the amplitude of the cycle. Thus, markets will tend to move more (i.e., display greater price variability) over a monthly time frame than over a daily one. Because larger time frames exert influences on shorter ones and multiple time frames are nested, no one cycle is identical to others. Traders looking for precise patterns or timing rules to recur are apt to face disappointment. The goal of the trader should be to try to *identify* cycles that we're in and frame viable hypotheses from this identification. That is very different than trying to predict precise price action from a given cyclical formulation. Once again, I'll be providing examples of this as we move along.

4) Trade Execution and Management - An understanding of cycles will help us differentiate the generation of trade ideas (which occurs at one cycle level) and the execution and management of that trade (which occurs at one time frame lower). This is a very important concept that will guide work on improving our trading performance.

The value of a conceptual framework is its ability to guide our understanding and behavior and organize our observations in meaningful ways. Psychoanalysis is one framework for understanding people; behaviorism is another. Buddhism is one framework for spiritual life; Judaism is another. A useful framework is one that speaks to you and that you can actually apply in constructive ways. In this course, we'll be building one framework that has made sense to me over 30+ years of trading. Your job is to consider it, find what--if anything--speaks to you, and then integrate that information into your own experience and understanding.

The goal of this "Introduction to Trading" is to make you your own guru; to help you sharpen your own views and understandings of markets. The idea is not to follow me, but to lead yourself. My job is to offer a few tools that might be useful in that process.


LINK:
TraderFeed: An Introduction to Trading: Cycles and Their Implications

The mentioned prior post from the same source:

"Stock Market Cycles:



My initial post in this series focused on the importance of approaching the markets with a conceptual framework. In this post, I want to take a step back and explain to readers how I view movements in the stock market. This is a conceptual structure that helps me to think about how the moves in today's market relate to those from the day before--and the day to come. This structure applies not only to daily market movement, but also movement on smaller and larger time frames. I claim no originality in this presentation; I think you'll find related concepts from a host of technicians, from Joseph Granville to Stan Weinstein to George Lindsay. Indeed, much of technical analysis lore--from double-bottom and head-and-shoulders patterns to oscillator and indicator divergences--spring from this kind of conceptual structure.

The key idea is that markets, at any time frame, move in aperiodic cycles. A cycle is a structure that includes two or more market tops and/or bottoms. Like snowflakes, cycles have several defining features, but no two cycles are completely identical. Cycles are aperiodic in that tops and bottoms do not occur at regular, predictable time periods. These cyclical structures occur on an intraday basis, swing basis, and over longer periods of weeks and months.

The chart above is a highly idealized view of a market cycle. It begins with a sharp upward movement from a low point, with broad participation in the rise. The bull move attracts interest--and often volume--until we hit a point of maximum upward momentum and strength, which I have labeled as a momentum high. At a momentum peak, we will typically see a large number of stocks making new highs relative to new lows; we'll also often see expanded volume; and overbought readings on many market oscillators.

The higher prices attract sellers and a decline ensues that is a more significant decline than had been seen during the prior rise. I've labeled this as a "separating decline", adopting a term from Lindsay. During this decline, certain market sectors hold up relatively well; others dip significantly. Market indicators will typically move from overbought to more neutral levels and, we will typically see a reversal of prior action in bonds, currencies, and/or commodities. This alerts us to the possibility that something is shifting in the financial landscape.

From this separating decline, we typically get one or more subsequent rallies, often that take the broad market indexes to new price highs. At these highs, however, we frequently see fewer stocks making new highs, fewer sectors participating in the strength, and weaker upside momentum readings. Very often, we'll also see non-confirming action in those correlated markets: interest rates, commodities, and currencies. As the market makes these fresh price highs, upside strength and momentum are waning. Divergences begin to accumulate.

With the waning upside, those shifts among asset classes lead to selling pressure in the broad indexes, taking the majority of shares lower. This decline continues until we hit a point of maximum downside momentum, at which we see stocks making new lows dramatically outnumbering those making new highs; a typical expansion of volume on panic selling; and very weak oscillator readings.

Here, too, this point of maximum downside momentum tends to be followed by a separating rise that is notably stronger than the upside reversals that occurred during the market's downward move. Some sectors bounce very strongly off their lows; others rise only a little. This bounce is commonly accompanied by a move to more neutral momentum and strength readings in indicators. Not infrequently, we'll also see reversal moves in interest rates, currencies, and/or commodities.

This rise is followed by one or more subsequent declines that may take the broad indexes to fresh price lows. During this latter decline, we see fewer stocks making fresh new lows, reduced downside momentum, and divergences among many market indicators. We may also see non-confirming action in those related asset classes. This waning of selling then emboldens buyers, and we start a fresh cycle.

The nesting of these cycles within one another means that any given cycle will have a shape that is partially determined by the cycles of higher-order magnitude. If the market on a longer time frame is in a rallying mode, for example, a short-term cycle will tend to have an elongated rise and a modest subsequent decline. The structural qualities of the cycles will typically be present, but their timing and shapes will vary, fooling many traders.

It takes a while to train your analytic eye to perceive these cycles. On a large time frame, for instance, we had a bottom in October, 1998, a momentum peak in the stock market in the first quarter of 2000, a price peak in the Dow during 2001, a momentum trough in October, 2002, and a price low in March, 2003. That was one big cyclical movement.

More recently, we had a momentum peak in June, 2007; a price peak in October of that year; a momentum low in January, 2008; and we--I believe--are making subsequent price lows in July and now in September of that year. If that analysis is correct, the next significant market cycle should be to the upside.

Note that this is not a precise timing tool, a mystical numerological scheme, or a mechanical trading system. It is a conceptual framework that guides thinking as to two important market issues:

1) Is the market getting stronger or weaker over time?

2) How is the market action at one time frame linked to that at other time frames?

But why would we see such structural similarities among market movements? That question will be the topic of the next post in this series and will form a second leg to our developing conceptual structure."

LINK:
TraderFeed: An Introduction to Trading: Stock Market Cycles

Good thread

Real good posts markus



Andy

Excellent contribution ,, if people of this BB just read this article in details they get one step ahead of every one else

Grey1

I like the idea of cycle analysis and it's an area of trading that I want to investigate further as I know very little about it. However, it strikes me that there is one obvious trap for those who try to make use of it. Dr. Brett Steenbarger states that "with this notion of cyclical structure as part of a conceptual framework for trading, it is possible to generate ideas of likely market action based upon: 1) where we are at in the current market cycle and 2) where the current cycle is situated within cycles at longer time frames." For many traders, Joe Ross' famous mantra 'trade what you see and not what you think' is more than just a trading cliche, it's central to the way they operate. And with good reason; it makes a lot of sense to trade on the basis of what the market is doing right now (present) rather than what you think it might do in five minutes, five months or five years time (future). As soon as one starts to construct a 'conceptual framework' for market direction, then there is a paradigm shift from trading what one sees (present) to trading what one thinks (future). The obvious trap I mentioned at the start is if our analysis leads us to conclude (as Dr. Steenbarger's does in his article) that - for example - the market is making price lows, we then start looking for opportunities to go long. If the analysis is correct, we do very nicely. However, If it's wrong, we get caned. Meanwhile, the 'trade what you see - not what you think' brigade do okay whatever the market does because they have no conceptual framework about where the market is in its cycle or where it's next heading. They won't fall victim to trying to force square pegs into round holes.
Tim.

Another cycle the infamous 90% in the trading game are probably more familiar with than Brett Steenbargers cycles above.

BSD said:

Another cycle the infamous 90% in the trading game are probably more familiar with than Brett Steenbargers cycles above.

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ROLF awesomeeeeeeeeeeeeeeeeeeee


heheh

Yeah, good huh, haha, and soooooo true, I think...

BSD said:

Note that this is not a precise timing tool, a mystical numerological scheme, or a mechanical trading system. It is a conceptual framework that guides thinking as to two important market issues:

1) Is the market getting stronger or weaker over time?

2) How is the market action at one time frame linked to that at other time frames?

But why would we see such structural similarities among market movements? That question will be the topic of the next post in this series and will form a second leg to our developing conceptual structure."[/B]

LINK:
TraderFeed: An Introduction to Trading: Stock Market Cycles

Click to expand...

Thanks for the posts, BSD.

It's funny how we all see the same stuff, the price action that Brett explains and shows in chart form is so ingrained in my head, great cyclical movement, i get a semi on looking at it (what a geek i am).


Brett has asked some quite thought provoking questions here, i hope they get the attention they deserve.


Is the next bit of the story out yet, mate?

Is the market getting weaker or stronger over time?

Mmm, i don't know, are the bigger cycles getting bigger or smaller, does this matter? In terms of technology/scientific growth, commodity production, population growth, standard of living....everything seems to grow, it's got to grow, but at some time in the future it's all got to fail, has it?

I don't know. Interesting stuff.

Are we heading for one big self supporting super race of humans in the future, no wars, no hunger, just an ability to exist anywhere and create anything? That's evolution, but it's got to happen in a 'natural' fashion i suppose, mother nature is not to be rushed. Anyway, i'm waffling.

OK. i think the markets will always become stronger. Reason: values are always reworked to progression (evolution) and not regression in the bigger picture.

Have you started drinking early Paul? It's only five to nine.

options said:

Have you started drinking early Paul? It's only five to nine.

Click to expand...

I don't drink anymore, oppy. Crystal meth, is all i do these days.

Paul71 said:

I don't drink anymore, oppy. Crystal meth, is all i do these days.

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Ah! That would explain it. Lol

_________________________________________________________________
So is this line straight or is it a sine?


PS. This is also the secret to trading.

Serious though. How could the markets ever become weaker?

It can't happen, it won't happen, it's impossible. The only thing that can stop the markets is a large scale natural catastrophy.

Do you know what the markets have survived?

Two world wars and one world cup, do dah, do dah...

Two world wars and one world cup, oh dah do dah day!!!!!

Paul71 said:

Serious though. How could the markets ever become weaker?

It can't happen, it won't happen, it's impossible. The only thing that can stop the markets is a large scale natural catastrophy.

Click to expand...

That; and help from mankind!

I dunno, the older I get the more I hear people say it can't happen etc etc and it does, and a lot worse than before.

If the present conditions are not handled properly by the powers that be, then it will get a lot worse.

Seeing as this thread is about cycles. Everything moves in cycles. A CEO of a large private investment bank in the city told me many years ago that the financial world moves in 7 years cycles of boom and bust.

Quite where we are now. I honestly don't know. But I 'feel' as if we have further down to go.

What would normally happen around now is for a big war to start somewhere. That always takes the heat off the politicians, (the governors). Maybe we do have further to fall after all for it to become 'necessary'.

options said:

That; and help from mankind!

I dunno, the older I get the more I hear people say it can't happen etc etc and it does, and a lot worse than before.

If the present conditions are not handled properly by the powers that be, then it will get a lot worse.

Seeing as this thread is about cycles. Everything moves in cycles. A CEO of a large private investment bank in the city told me many years ago that the financial world moves in 7 years cycles of boom and bust.

Quite where we are now. I honestly don't know. But I 'feel' as if we have further down to go.

What would normally happen around now is for a big war to start somewhere. That always takes the heat off the politicians, (the governors). Maybe we do have further to fall after all for it to become 'necessary'.

Click to expand...

Wars are not so degenerative, quite the opposite. Wars are like a 'weeding' process, they give way for the new, and although war is not wanted, i suppose it's a nesseccity in some ways.

We are all part of something, that to some extent we have no control over, the only part we can control, leads us into the uncontrolable......we can't win, and ultimately, you have no decision.

Good trading.

I truly believe that all man made functions are for the benefit of the few to amass more wealth at the sufferance of the masses.

Another war? Would I fight for my country? Would I fcuk !!!

No matter what part of the cycle we are in.