Only one person sells the high and only one person buys the low. They both do it for the same reason: they were lucky. Take your trade right out of the middle.

- Tom Zabroske

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August 22, 2007

Are you listening? You should be!

Walsh Trading is pleased to announce the Walsh Trade Voice (WTV) 2007 Cornbelt Snapshot Tour report has begun. With quality first hand information you cannot get anywhere else, the Cornbelt Snapshot can be heard live at 7:35 AM, CST on WTV and in its recorded version once the live broadcast is completed. The 2007 Cornbelt Snapshot Tour features input from 8 diverse locations throughout the entire U.S. Cornbelt. Listen now!

The following article is written as an introduction to the concept of utilizing cycle analysis in trading. The mathematics involved in determining cycle lengths and the various components is material for a future article, as is the interpretation of the interaction of cycles between various time frames.

Mark Twain once said: “The same Nature which delights in periodical repetition in the skies is the Nature which orders the affairs of Earth. Let us not underrate the value of that hint.”

Every day, we experience, participate, and revolve around a myriad of cycles occurring in Nature. Smile or snicker if you want regarding the following examples, but precise mathematics is at the core of all these examples, the same mathematics used to probe the solar system, the same mathematics used to delve into sub-atomic particle physics.

The orbit of Earth around the Sun results in cycles we refer to as seasons. The revolution of the Earth on its axis results in cycles we refer to as night and day. The orbit of the Moon around the Earth results in cycles clearly evident in the sky as we gaze upward and see the New Moon cycle in a 28-day pattern. Even the sounds we hear are created by cyclical waves, each resulting in a specific tone. Daily, each one of us, whether we are aware of it or not, experiences circadian cycles or rhythms controlling alertness and tiredness. Monthly biological cycles are also present in the human species. Cycles in Nature can also be found on the sub-atomic level, as electrons circle the nucleus. The examples of cyclical behavior in Nature go on and on, endlessly. The key to grasp is that cycles are measured across the horizontal axis: the time axis.

So too, markets exhibit cyclical behavior. These cycles manifest themselves across the horizontal axis, or time axis, in durations measured in years, months, weeks, days, and even on a minute-by-minute time frame. Utilizing an understanding of just what phase these various cycles are in and their interaction with each other can be a powerful tool to add to your toolbox in the quest for successful trading. Whether your decision-making process starts with fundamental analysis or technical analysis, an awareness of the cyclical picture is a necessary adjunct to either decision making process.

How many times has a bullish report been released, only to see the market make a high and reverse? How many times has a bearish report been released, only to see the market make a low and reverse? How many times has there been a specific technical formation, whether bullish or bearish, that has failed? How many “key reversals” have been anything but? The market’s failure to react positively to a bullish report or negatively to a bearish report can be explained by looking at cycles. The same can be said of failed technical formations. It is simply a case of not being the right time for the report or formation to have the expected result.

METHODOLOGY

By utilizing an understanding of the cyclical picture of a market, one can incorporate an understanding into the horizontal, or time, component of the market. While most traders, both fundamental and technical, have a good understanding of the vertical, or price, axis of the market, the horizontal, or time, axis is a mystery.

A very important concept to grasp regarding cycles is this: if a particular time frame has made its cycle high, one’s natural inclination would be to expect to see the market then trade to the downside. While this is generally true, more importantly, a cycle high has more to do with the cessation of the up-move and not necessarily portending a downward move in price. The same is true with a cycle low: one’s natural inclination would be to expect the market to rally. While this is generally true, more importantly, a cycle low has more to do with the cessation of the down move and not necessarily portending an up-move in price. At cyclical extremes, either the market will reverse or go into a consolidation phase.

A cycle is measured from low to low. If the market makes a cycle low on bar 1, and the cycle length is 20 bars, the expectation would be to see the market make another low on bar 20. The time frame of the bar is irrelevant. If you were looking at a 20-bar cycle on the monthly time frame, the expectation would be to see the next low 20 months from the initial bar of the low. The same is true of all time frames, whether they be weekly, daily, or intraday.

If you cannot view the example cycle bar, go here.

In a perfectly balanced situation, the high of the 20-bar cycle would be 10 bars out, 10 bars up, and 10 bars down, netting a 20-bar cycle from low to low.

If you cannot view the example “balanced cycle”, go here.

Now the issue of translation comes into play. When looking at the cyclical picture of a market, multiple time frames must be incorporated into the analysis. The primary time frames are: monthly, weekly, daily, and intraday. Each larger time frame influences all of the time frames underneath it. A good analogy would be to think of the monthly cycle as the whole forest, the weekly cycle as one specific tree in the forest, the daily cycle as one specific limb on the tree, and, finally, the intraday cycle as a specific branch on that limb.

For example, if the intraday cycle is in its up-phase, while the daily cycle is in its down phase, one would expect to see the bearish influence of the daily time frame affect the intraday cycle and prevent the intraday cycle from making its high at the halfway point of the cycle or later. An early high would be expected on the intraday cycle as the daily cycle adds its bearish influence on the intraday cycle. This is known as translation, and in this specific case, as left hand translation…that is an early high in the cycle. In this example, 5 bars up and 15 bars down. Left hand translation is a bearish phenomenon.

If you cannot view the example “down cycle”, go here.

Conversely, if the daily cycle is in its up-phase and the intraday cycle is also in its up-phase, one would expect to see the intraday cycle peak at or past its halfway point, as the daily cycle adds its bullish influence to the intraday cycle. This is known as right hand translation…that is a late high in the cycle. In this example, 15 bars up and 5 bars down. Right hand translation is a bullish phenomenon.

If you cannot view the example “up cycle”, go here.

Everyone has heard the old adage: “Trade with the trend.” This same concept can be applied to cycle analysis. Trade in the direction of the cycle on the larger time frame than the time frame you are trading on. For example, if you are a day trader and the daily cycle is in its down phase, you should be trading intraday from the short side of the market.

Above all, the monthly cycle is the most important time frame to be aware of when using cyclical analysis. While no market goes straight up or straight down, the general bias of the market will be determined by the monthly cycle and this should govern trading decisions.

Tom Zabroske has been in the futures markets since 1978. Tom has lectured nationally and internationally on market cycles as well as other subjects, and has been a featured speaker at many futures conferences over the years. He writes a market commentary Monday thru Thursday concerning market cycles titled "Circuli Dominare," which is available through Walsh Publications Inc.

Tom is currently the Senior Trader/Analyst as well as Director of Research for Walsh Trading Inc.

Are you listening? You should be!

Walsh Trading is pleased to announce the Walsh Trade Voice (WTV) 2007 Cornbelt Snapshot Tour report has begun. With quality first hand information you cannot get anywhere else, the Cornbelt Snapshot can be heard live at 7:35 AM, CST on WTV and in its recorded version once the live broadcast is completed. The 2007 Cornbelt Snapshot Tour features input from 8 diverse locations throughout the entire U.S. Cornbelt. Listen now!