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Market Cycle |
Wednesday, 31 December 2008 11:21 GMT
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Regular readers of my reports will probably recognize that I use cycle
analysis when trying to work out which direction a currency pair will
be moving and when this direction is likely to reverse.
So what do these look like and how do they work?
The following chart shows the cycles I have been using to identify the
major cycle low in Dollar-Yen back in August, from which time I have
been bullish over the rest of this year.
You can easily see how the blue, red and pink cycle lows all match a
major price low and generally generate a significant rally. Having said
that, this isn’t true in one instance and that is at the blue
cycle low in 2002. The reason is that both red and pink cycles were
declining and out weighing the upward influence of the less powerful
blue cycle.
Indeed, this is one of the features of cycles that can be used to judge
the power of a move. Let’s look at this a little closer.
Cycles should hold to four basic characteristics:
- Synchronization
- Harmonization
- Proportionality
- Summation
Synchronicity is the characteristic that dictates
that all cycles should find lows as approximately the same time.
Harmonization is the characteristic that dictates
that cycles tend to have a relationship of half the frequency of the
next larger cycle.
Proportionality is the characteristic that dictates
that the “force” or “power” of
a cycle is double that of the next smaller cycle.
Summation is the characteristic that dictates that
the net impact of the cycles can be determined by adding the individual
power of each cycle at any particular time.
The following chart provides a graphical interpretation of
synchronicity and proportionality:
Here it can be seen that two smaller cycles will fit into the next
larger cycle and as such there will be a pattern of cycle lows where
different cycles all find lows at the same time.
Also if the amplitude (height) of one cycle is 1x then the next larger
cycle will have an amplitude of 2x, the next larger of 3x. If you can
imagine that 1x is a measurement of force, then each larger cycle has a
force of double that of the next smaller cycle. Thus by the fourth
cycle (red) the force is 8x.
The following chart explains the theory of summation a little better:
At each point I have marked the value of each individual cycle
– note how they increase by 2x for each larger cycle. By
taking any point it is possible to discover the net impact of all the
cycles.
So generally, the larger the cycle, the stronger the force will be. As
such, I don’t normally look at any cycles shorter than daily
since intraday cycles will be overwhelmed by the weekly and monthly
cycles.
So now that we have seen a basic idea of how cyclic forces work,
let’s look at one chart to observe the reactions.
We’ll make this the weekly chart of Dollar-Yen that was shown
above:
I have numbered the major weekly cycle lows where we have seen
convergence of at least 3 cycles which basically means at each low of
the blue cycle.
1. This is the 79.70 historic low in 1995 where all five cycles found a
low – and probably also the next larger cycle. (Imagine a
cycle drawn from this low which rises to find a peak at point 5 and is
now declining.) The decline into the cycle low was exceptionally rapid
– probably the most violent move I have seen in 25 years. On
one day just before the eventual low it opened at 83.67, declined to
80.18 and closed back at 84.38. Much of this occurred in approximately
one hour in the morning.
This highlights the extreme power of a group of long term cycles. In
approximately 3 ½ months Dollar-Yen declined from 101 down
to 79.70 and then rallied back up to 101 in around 5 months. This shows
that the cycles were as aggressive in the recovery as they were in the
decline.
2. The correction was both quite shallow and very brief which is a
factor of the combined strength of the pink and red cycles together wit
the next (undrawn) cycle described in point 1. This shows how the
larger cycles can overwhelm the shorter cycles.
3. Following the peak at 147.63 we saw a much deeper and stronger
pullback into the red cycle low. Note that this occurs at the pink
cycle high but the combined downward force of the 4 smaller cycles were
sufficient to pull price lower in a forceful way. We should realize at
this point that since the pink cycle is still high and we are also
seeing the 4 smaller cycles rise again that we should see a strong move
higher. This occurred with the eventual peak occurring just before the
peak of the red cycle.
4. From that peak the decline makes it lower but since the pink cycle
is still quite high and the red cycle is at a peak, the decline
didn’t fall too far. However, with the effect of a declining
pink cycle and now a declining red cycle, the recovery from point 4
failed to make much impact.
5. Since we began to get a reversal lower without much of a recovery
from point 4 and the red and pink cycles began to decline we could
anticipate a sustained move lower. Here is an interesting point. By the
time all 5 cycles make a low at the same time, price fails to move
below the low at point 3. Why is that? Well, it would be because the
next larger cycle (above the pink cycle) would then be at a cycle high
so is pulling price higher and preventing a larger decline. As you
should now be able to work out, the reversal higher of 5 cycles
generates a strong and sustained rally that finally peaked at 124.13
earlier this year. This is interesting since the peak was seen so close
to the end of the blue cycle which demonstrates the upward force of the
red and pink cycles along with what is now a declining, but still high,
next larger cycle.
6. In August we saw a cycle low of the three smaller cycles. We have a
high red cycle, a rising pink cycle but a declining larger cycle. Note
how the price low in August was significantly above the low at point 5
which shows the upward force of the longer cycles. By my reckoning it
should provide upward strength for the coming year at least. If you
consider that the pink cycle is rising and at a similar level (and
therefore force) as point 4, but is seeing a declining (but still high)
larger cycle we should see strength that should overcome the 124.13
high over the coming year. Whether it can make it to the 135.14
corrective high is debatable and probably unlikely but somewhere in
between is a distinct possibility. However, beyond that the red cycle
will decline into the end of 2009 which should see a strong decline in
that year.
In a later article I shall discuss how to apply cycles to your charts.
Written by： gftforex.com
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