Rhythms of Time Cycles in Financial Markets
Modeling Market Cycles from Fixed Lengths to Dynamical Systems
Mar 13, 2009
Market analysts of finance and economics have long been aware of the existence of market cycles.
Financial market cycles are thought to relate to the behavior patterns of individual market participants acting en masse, i.e. as a crowd. Investor sentiment continually changes in a limit cycle - moving from greed, which causes prices to rise, to fear, which causes prices to fall.
A knowledge of cycle theory can be used to measure the natural rhythm of markets, and this information may be used for timing and entering a trade.
Market Trends a Superposition of Price Cycles
Unfortunately, many market technicians in the past have searched for regular, or periodic cycles. This tradition goes back to using basic science concepts - for example, Dewey and Dakin and many others since, modeled price fluctuations as a simple superposition of waves of different frequencies (cycles).
This technique was fine for the short term but problems occurred when looking for cycles in the longer term. Edward Dewey later showed there were problems with two cycles with slightly different periodicities. They might start in phase but eventually will cancel each other out – the cycle will disappear.
In general, investigation of markets using fixed cycle theories has many drawbacks as it assumes the apparent tendency of such phenomena as price movements, weather habits, sun spots, cattle production, etc., to continue in one trend for a fixed number of weeks, months, or years, before reversing to the opposite direction.
Market Cycles Not of Fixed Length
According to Edgar Peters, there is no intuitive reason for believing that the underlying basis of market or economic cycles has anything to do with periodic cycles. Market cycles are actually aperiodic or dynamic – meaning they expand or contract over time, a feature of chaos theory and the fractal nature of markets.
One of the first cyclical theories was by Ralph N. Elliott. His Wave Principle is able to model the fractal nature of markets and can be applied to all types of long-range or short-range price charts, as long as the subject involves mass behavior. Elliott’s major contribution to cycle analysis was that each wave of similar degree must relate in both price and time.
Each Market Has Own Dynamical System
According to Elliott, markets move in price and time from highs to lows and lows to highs in minor trends, intermediate trends, and primary trends.
Each trend of similar degree is the direct effect of an underlying cause – the constant vibration of numerous cycles at work. According to Bryce Gilmore, on many occasions, market trends change with important cycle events, classified as:
- Fundamental Cycles due to the regularity of profit reports, production reports, crop estimate report, Federal Reserve board meetings, G8 meetings, government elections, etc.
- Natural Cycles, or seasonal cycles, as a result of the mechanical movements between the earth, the moon and the sun.
- Planetary Cycles due to the movement of the planetary system. Gilmore believes that the relative position of planets is important but is a secondary effect on market cycles.
Tools to Measure Cycles
There are relatively few market tools or software to measure cycles and take advantage of them. Some traders use simple tools ranging from those applicable to the fixed cycle: Fibonacci time retracement tool and W.D. Gann's tools, to those applicable to the dynamic cycle: for example, "CycleTrader", Gilmore's sophisticated time cycle software.
References:
- "Cycles - the Science of Prediction", Edward R. Dewey and Edwin F. Dakin, Henry Holt & Co, NY, 1947.
- "Fractal Market Analysis - Applying Chaos Theory to Investment & Economics". Edgar E. Peters. John Wiley & Sons, NY. 1994.
- “W.D. Gann Analysis Techniques”, in Dynamic Time & Price Analysis of Market Trends, Chapter 10. Bryce Gilmore. Helensvale, Australia. 1999.
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