How to apply cycle theory to financial markets? | R Blog RU


Traders seek to find patterns in the markets in order to try to capitalize on this. Some look for complex trading strategies or price patterns on charts, while others estimate the length and height of price fluctuations. You can also estimate the likelihood of growth or decline based on cyclic theory price behavior.

We can say that cycles take into account the time intervals in which certain events occur, for example, a change in the trend in the market. The cycle of growth is replaced by a cycle of decline, then the cycle of price growth begins again. It is believed that the trend movement takes 30% of the instrument’s behavior in the market, and the remaining 70% is occupied by a sideways trend.

We often trade and are not tied to the time of reaching target levels. In general, the practice of estimating by the time of price movement is not very widespread. But it is worth noting that some authors try to cling to this theory.

Bill Wolfe, the author of the Wolfe Waves method, gives an idea of ​​how to determine the time to reach a goal. Therefore, when making a deal, the investor understands that he will have to wait several hours or days and should not expect a quick profit on this position.

Unfortunately, each author distinguishes his own cycles and endows them with separate properties. In this article, we will try to figure out how to use the types of cycles in some options for market analysis. It is possible that individual traders will have their own ideas about the cycles of market behavior and their areas of application.

What cycles can there be?

Cyclicity is inherent in all areas of life. John Murphy in his book “Technical Analysis of Futures Markets” gives examples of the study of cycles in the distant 1940s. The study of cyclicality covers the sphere of construction, the movement of the securities market, entrepreneurial activity, and so on.

Within the framework of the needs of trading and investment, the following types of cycles are distinguished:

  • Time cycles in which we estimate price fluctuations with reference to time.
  • Seasonal cycles. Here we are talking about strong fluctuations depending on weather conditions.
  • Event cycles, when an event provokes a price movement, and this behavior of an asset is repeated.

Why study the cyclicity of instruments?

First and foremost, the purpose of studying cycles is to try to predict market behavior. If an investor has studied the price movement of an asset and the factors influencing it, he can determine the patterns in which strong price movements occur. Next, the investor’s goal is to try to make money from it.

Time cycles in the stock market

After the 2008 economic crisis, analysts expected a repeat of the same situation in 2018. Allegedly, the time cycle, within which a new crisis is formed, provoking a massive collapse in the stock market, the growth of gold and the strengthening of the US dollar, should occur every 10 years.

However, signs of a global crisis appeared only in 2020 due to severe economic instability and the global coronavirus pandemic. We can say that in this case there was a time lag, but expectations were justified.

The Dow Jones Stock Index fell from 29,000 points to 18,300 points in 2020. If we look at the chart for 2008, the fall was just as strong: the index fell from 13,700 points to 6,600 points.

Dow Jones Index Chart

The Dow Jones began growing in March-April 2008, and in exactly the same way repeated the same growth in March-April 2020.

Dow Jones Index Chart

Consequently, another serious drop in the index can be expected in the period 2028-2030, and the development of growth is just beginning. Of course, it makes sense not only to focus on these dates, but also to monitor the situation in the markets and, if possible, look for confirming signals in favor of such a movement. Do not forget about the time lag, which can slightly shift the exact dates of the next collapse.

Event cycles in the cryptocurrency market

An illustrative example of an event loop is Bitcoin halving. The market has already experienced three network complications, and each time after this event the price set a new maximum for 4-6 months. The peak was reached within a year and a half, after which the market went into correction until the next halving.

Bitcoin Chart

Based on these data, it is recommended to buy Bitcoin some time after the halving and hold the asset for one and a half or two years, then exit the market and consider opening short positions, or wait for the next cycle.

Bitcoin halving happens regularly, so it’s easy to catch next time. But not all event loops are so clear and understandable.

Seasonal oil price cycles

If we take and evaluate the oil chart for the last 5 years, then we can see the growth of quotations in July each year. This event is likely related to worsening weather conditions in the Gulf of Mexico, when severe hurricanes force oil workers to reduce production of raw materials. Of course, when a major hurricane looms, all oil production is threatened. Therefore, the market takes these seasonal events into account and demonstrates the rise in oil prices within the next cycle.

Brent oil chart

Timing cycles work well with oil as well. Back in September 2013, reports began to appear that oil prices are close to local highs, and there are risks to see a fall. However, the decline in prices for “black gold” does not pass quickly, but may take several years. Such a study was carried out Jose Antonio Ocampo… He proceeded from the assumption that, like the entire world economy, oil prices move cyclically, therefore, growth and fall follow each other in strict time frames, and we should expect a new fall only in 2020. A record decline in oil prices occurred last year. But it is worth noting that the fall was also observed in 2014.

Jp morgan chase talks about a new super cycle of growth in the commodity markets. Allegedly, only in the last 100 years, four such cycles have been noted, the last of them began in 1996 and ended in 2008. Prices are already actively growing and there is serious potential for continuing this rise in 2021 and 2022.

Brent oil chart

Among the reasons for the development of such a movement may be the general recovery of the world economy after the pandemic, as well as a serious fight against climate change. The latter, in turn, will provoke a limitation in oil production and at the same time an increased demand for raw materials to create an infrastructure for renewable energy sources.

Conclusion

Each trader can have a different understanding and application of cycle theory. More often, investors assess the probability of occurrence of events in the market with reference to the waiting time for this event.

The price behavior is cyclical, so events will repeat themselves with some frequency. In this case, it is not even always necessary to look at the chart itself, provided that the trader has previously studied the behavior of the instrument and determined the events or time frames for the formation of the next cycle.

Examples of cycle theory are observed in the cryptocurrency market, in particular, Bitcoin halving leads to an active growth of the entire digital asset market, which then goes into a protracted downward correction until the next bull cycle. This happens every few years. Now we are just seeing an upward movement of digital assets as part of the development of this cycle.

Some banks are already talking about a new super cycle of growth in the raw materials market, while oil quotes are steadily moving up. And the fall that the market saw in the past, in 2020, was predicted by some analysts back in 2013.


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