How to Use the Cycle Theory in Financial Markets?

How to Use the Cycle Theory in Financial Markets?

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Traders are always looking for certain patterns in the market to try and make money on them. Some want complicated trading strategies and price patterns on the charts, others assess the length and height of price fluctuations. Moreover, one can assess the probability of a decline or growth based on the price cycle theory.

You can say that cycles account for periods when certain events take place – for example, the market trend changes. A cycle of growth changes for a cycle of decline, then another cycle of growth comes. There is a view that trends take some 30% of instrument behavior, while the remaining 70% are given for flats.

Quite often we trade without orientation on the time when our goals will be reached. On the whole, time-wise price estimations are not quite widespread. However, mind that some authors clench at this theory.

Bill Wolfe, the author of the Wolfe Waves, gives an idea of how to define the time when the goal will be reached. With this, an investor knows that they will have to wait several hours or even days and does not hope for a quick profit.

Unfortunately, every author invents their own cycles and gives them new properties. Below, let us try to figure out how to use various types of cycles in certain variants of market analysis. Any of you might have, however, your own ideas about cycle types and their use.

What cycles are there?

Life consists of cycles. John Murphy in his book “Technical Analysis of the Futures Markets” gives examples of cycle studies from as long ago as the 1940s. Cycle studies apply to the construction, stock markets, business, etc.

In trading and investing, we have the following types of cycles:

  • Time cycles are meant for estimating price fluctuations time-wise.
  • Seasonal cycles, by which we mean noticeable price fluctuations due to weather conditions.
  • Event cycles, which means that certain events provoke certain price movements, and this behavior repeats.

What do you need cycle studies for?

Firstly, we study cycles in attempts to predict market behavior. If the investor has studied price movements in an asset and the factors that influence it, they might try to detect patterns that include noticeable price movements. The next goal will be making money on this.

Time cycles in the stock market

After the economic crisis of 2008, analysts expected the same situation to repeat itself in 2018. They claimed that the time cycle, in which a new crisis forms, provoking a massive decline in the stocks market, the growth of gold and the USD, lasts 10 years.

However, the evidence of a global crisis showed itself in 2020 only due to serious economic instability and the pandemic of the coronavirus. We can say that there happened a time lag but on the whole, the expectations were met.

The Dow Jones index dropped from 29,000 points to 18,300 points in 2020. On the chart of 2008, the decline was equally massive: the index dropped from 13,700 to 6,600 points.

Dow Jones price chart

Dow Jones started growing in March-April 2008, and the same happened in March-April 2020.

Dow Jones price chart

Hence, we can expect another serious decline of the index in 2028-2030, while its growth is just beginning. Clearly, you do not have to stick to these dates only: track the situation in the market and try to find confirmations of these forecasts. Keep in mind the time lag as well.

Seasonal cycles in oil prices

If we assess the chart of oil prices of the last 5 years, we can notice the quotations grow every July. This might be due to bad weather in the Gulf of Mexico: severe hurricanes make oil production drop. Of course, an approaching storm threatens oil production. Hence, the market accounts for such seasonal events and raises oil prices inside each cycle.

Brent Crude Oil price chart

Time cycles also work well in oil. As long ago as September 2013 we heard of oil approaching local highs, so we risk witnessing a decline. However, the decline does not happen at once, it might take years. This was the conclusion made by Jose Antonio Ocampo. He supposed that the whole of the global economy goes in cycles, growth changes for declines and back strictly time-wise, so we should expect a new decline in 2020 only. That year, oil prices demonstrated a record falling. However, note that the prices dropped in 2014 as well.

JPMorgan Chase speaks about a new super-cycle of growth in commodity markets. They say that in the last 100 years, there were only 4 such cycles, and the last one started in 1996 and ended in 2008. Prices are already growing noticeably, and there is serious potential for growth in 2021 and 2022.

Brent Crude Oil price chart

The reasons for this might include general recuperation of the world economy after the pandemic, as well as the serious struggle against climate change. The latter reason will provoke a serious cut in oil production and a surge in the oil demand meant to create the infrastructure of renewable energy sources.

Bottom line

Every trader might have their own understanding and use of the cycle theory. Most often, investors assess the probability of certain events time-wise.

Prices go in cycles, so events will repeat themselves. You do not even need to look at the chart, provided that you have studied the behavior of the price and detected periods or events that form new cycles.

Some banks are already talking about new super-cycles of growth in commodity markets, and the quotations are going up steadily. And the decline we saw in 2020, was predicted as long ago as in 2013.




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