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Cycle Behavior in the Stock Market

Our job at predicting and timing the market would be made a whole lot simpler if cycles were always perfectly formed, and never changed in frequency or strength. But in reality,  over time, they do gradually change in both parameters. Their peaks will tend to skew right or left depending on whether they are in a bull or bear trend. They also tend to become flattened, or "damped" during trending periods in the markets.

We'll cover several of the conditions that can affect our Forecast, but let's first begin with a basic cycle chart created from imaginary data, but not too different from what an actual stock chart might look like.

In the chart above, are three cycles, representing what could be referred to as the long, intermediate, and short term cycles.  The middle series on the graphs shows the intermediate and short term cycles "imposed" on top of the longer term cycle. That view helps show how each cycle behaves independently, but follows the longer trend as they move through their cyclic advancing and declining phases.

In the upper series, only one line is plotted. It represents the summed total of all three cycles. You'll note, that the long term cycle gives that graph its overall trend, while the intermediate cycle adds to or takes away from that trend when is, or is not, moving in the same direction. We call opposing cycle movement in the market - "counter-trend".

Cycle Damping Effect

The longer the trend, the stronger its influence. That is especially true when the long term cycle is in a "trending" period and stock markets move in a more sustained bull or bear trend, versus a transitional period where market can get much more choppy, such as cyclical tops or a bottoms.

You can see that damping effect on the price of stocks from the following graph:

Notice that in bars 51-151, the long term (dark blue line) is trending down, and is the intermediate cycle (purple). In that bearish trend, shorter term cycle are "damped" or compressed, and hardly noticeable on the upper light blue summation line (which would be the stock's price). Compare that to their more noticeably larger moves when long term and intermediate cycles are transitioning (or topping, in bars 401-451).

That's why we try to stay in each longer term trend as long as possible. We avoid timing our trades from the shorter term "counter-trend" cycles during a stronger trending phase. If anything, during a trending period, we'll use counter-trend moves as a method to time our entry or re-entry into the longer trend.

It is also why we say, "don't trade against the intermediate cycle". The intermediate cycle is one of the most cyclically active components in the market, and can last from 4-12 weeks in its trending phase.

The only thing that will affect the intermediate cycle's strength, is the direction of the long term cycle. When both are moving in the same direction, be prepared for some very strong trends that can last 4-12 weeks. When opposing each other, look for extended periods of market chop.

During transitional periods however, when tops or bottoms are forming on the the long term or intermediate trend, we CAN trade begin to trade the short term rallies and retreats since they become pronounced during those periods.

Copyright 2001-2012 SCS Management, LLC. All rights reserved.

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