- 1998: Volume 7, No. 6 What Goes Around, Comes Around

Cyclical analysis is one of the only technical analysis processes that allows you to forecast, and therefore anticipate, a point in time in the future, when a market may reverse trend. This is possible due to historically repetitive rhythms in price action.

The chart in figure one depicts an excellent example of a 4-year cycle low series in the stock market. Having been aware of this cycle for many years, I'm quite impressed as to how it is evolving this particular time.

Figure 1

People often have trouble using cycles, because many different psychological factors are pointing in the wrong direction at the time the cycle should be turning. But that's how it's supposed to be. Adjusting to this seemingly backward way of thinking is contrary to our human nature. A current example in the stock market might be investor concern about the economies of other countries pulling down our market. But as you can see, if the cycle works, as it has in the past, the market should go up.

Here are a variety of ways to use cycles:

The classic method is to find a rhythm in the price action that has been consistent enough over a long enough time period to be considered a cycle. Once you have measured the cycle, you can then make a forecast as to when a market might bottom out or top out. Here comes the trick. As I mentioned earlier, it is very difficult for many traders to buy what appears to be a bear market, or to sell a bull market. And by the time the trader is convinced the cycle has turned as expected, a lot of the move has been lost. By combining a variety of technical tools with cyclical expectations you should be able to overcome these inherent problems, and be able to enter the market much closer to tops and bottoms.

"Key Reversals", are one of my favorite trading tools. I define a key reversal as a daily price range which has a high higher than the previous day's high, and a low lower than the previous day's low, this is referred to as an "outside trading range" day. Generally, when the close is higher than the previous days close, it should be a bullish signal. If I see this type of price action developing at a time when I'm expecting a cycle low, especially if there was some bearish news which the market did not respond to bearishly, I would be very optimistic, that a market turn was in progress. This combination of factors seems to have happened in the grain markets in the last two months.

"Divergence" type buy or sell signals often develop with several technical indicators, or studies, like RSI, Stochastics, MACD, and generally, momentum type indicators, during cyclical turns. This happens when markets make substantial moves, then have short-term relatively small reactions, and then make a new low or high for the trend, followed by a complete reversal of the trend. So the last lowest low or highest high seems to be perpetuating the overall trend. But in retrospect, it turns out to be a major reversal point. These types of divergence signals often occur at cyclic turning points. Watch out for them.

"Contrary opinion", is a useful tool, especially from a psychological standpoint. The classic way to use contrary opinion is to try and not be one of the crowd during extremely strong opinion time periods. In other words, if contrary opinion is at 90 or higher, therefore most traders are bullish, look for tell-tale topping out types of sell signals. Also if contrary opinion is that 15 or lower, look for similar buy signals. If you plot historical contrary opinion numbers you'll finder rhythms in the data.

Here is a trick I've learned. It's like doing things backwards. Look for rhythms in the technical studies, which you like to use first. Do this before you try to find cycles in the vertical bar chart. Because many technical studies are confined in a scale between zero and one hundred, it is easier to see rhythms in this kind of "confined" range. In fact, I recommend you don't even peak at the price chart first. By knowing what the market has done it will affect your judgment as to what cycles you might find in the vertical technical study. Finding cycles on a standard vertical bar chart, which may have very large, erratic, swings is much more difficult. It is generally difficult for most people to find cycles in standard daily vertical bar charts. The eye and the mind don't seem to work together very well for this purpose.

Although it seems somewhat obvious, seasonal tendencies are a form of yearly cycle. Personally, I find them a little sloppy, not as accurate timing wise as I would like, possibly because of their widely know presence.

Many different price patterns tend to occur at cyclic turning points. Keeping in mind that long-term cycle turns usually involve longer-term patterns, while short-term cycle turns involve short-term patterns, here are some examples. A multi-year cycle low may involve a bottom pattern, which would take a few months to develop (the current situation in grains for example). While a cycle of only a few weeks might involve a short term correction of only several days, (like the short-term cycle low of 22 week days in Live Cattle happening in early November, shown in figure two). That correction might retrace a classical Fibonacci retracement, close a previous gap, test a support or resistance area, test a trendline, etc.

Figure 2

"Head and Shoulder" patterns are very helpful in uncovering rythms. The amount of time from the first should to the head of the formation should be very similar to the amount of time from the head to the last shoulder, therefore providing three turning points which may have a previous, easily found history. Because of the symetry of this particular pattern, head and shoulders are my favorite patterns. Also it is easy to forecast when and at what price the market should turn during the last shoulder development.

"Channels" trap markets in trading ranges often making it easy to see cycles.

"Double Bottoms and Tops" and triple bottoms and tops (which are very rare) also provide a starting point from which you may find a cycle.

"Candle Stick" patterns can also be very helpful to pinpoint market turning points. My favorite is the engulfing pattern, which is similar to the key reversal.

Elliott Wave analysis uses cycles to help forecast "when" the beginning or end of particular "waves" may happen.

Moving averages which are back casted half the time frame of the moving average can help your eye see a cycle more clearly. This is an older but very useful technique for uncovering cycles that would otherwise be camouflaged by price action.

Cyclic forecasts don't always come true the way he we would like them to. What I mean by that is, sometimes the market may not exhibit any reversal of trend at or around the point in time when we expected it to. Also, cyclic highs and lows are known to occur sometimes a little earlier, or a little later than we expected, often called left or right translation. The tendency is for cycle highs to happen slightly early in bear trends and slightly late in bull trends. It's the opposite with cycle lows. And, to make things worse, we really don't know how much of a move the market may have if the cycle takes hold, although there are tools to help you forecast this size of moves.

This bit of reality awakening does not eliminate the incredible usefulness of cyclical analysis.

Many types of technical and or fundamental analysis involve "setups". Once you are skilled in these types of analysis techniques, adding cyclical research to your toolbox allows you to feel out the evolution of a market turn more clearly. When cycles work as they often do you can't beat the feeling of having figured out the market timing.

Stan Ehrlich can be reached at 1-800-323-7898. He offers a FREE e-mailed market recommendation "ECF Hot Line". Stan started in the Futures industry in 1971 and has; invented the Ehrlich Cycle Finder (1978), been written up in many books, appeared on CNBC, lectured world wide for 20 years for Dow Jones Telerate, Futures Magazine, Omega Research, and many others, brokered for several famous market analysis, written articles for several publications, and is still a Futures Broker, call me.