Cycles - How Do They Work?
A powerful technique to identify trends
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.
Ian Copsey
Global Forex Trading
http://www.gftforex.com
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