Use of Cycles for Technical Analysis

Cycles are trends or patterns that may be exhibited by the securities market. The trends or patterns directly affect prices, leading to seasonal or periodical fluctuations that may recur over and over again. Cycles may also lead to some securities outperforming others.

Breaking Down Cycles

Cycles exhibited within a particular industry may be induced by regulations or even a certain innovation. It’s common to find companies operating within the same industry experiencing similar growth patterns in terms of revenue and profits.

Market cycles rarely have an identifiable beginning or endpoint. However, experienced traders contend they exist, and many of them take buying and selling positions that they believe strategically put them in line for big profits. Capital markets, in particular, have recurring cycles of various frequencies.

A cycle can last anywhere between a couple of weeks to a few years. The  type of market in question is one of the main determinants of the duration. For instance, an equity trader may see up to four or five complete cycles within a single day. Cycles in real estate can last up to 20 years or even more. Let’s now look at a few well-known cycles:

The Presidential Cycle

The presidential cycle is perhaps one of the best examples of cycles that directly affect the stock market, bonds market, as well as the real estate and commodities market. Of utmost focus among market analysts is the United States’ four-year presidential cycle. Put simply, the theory about this cycle states that it’s during the first two years when most administrations make economic “sacrifices.” In the latter two-year period leading to the ballot, administrations have been observed to unleash every weapon in their economic boost arsenal in an attempt to stimulate the economy, create jobs and introduce a state of economic well being. This is particularly common when the president is seeking re-election.

The presidential theory explains why mortgage brokers and real estate experts advise clients to schedule mortgages to mature just before an election. The argument is that interest rates come down just prior to an election, hence reducing the repayment burden.

The 18-year Cycle

The 18-year cycle mostly affects the real estate sector, although it also has connections with equities and other capital markets. A short term recession occurs at the mid-point of the cycle, and a longer one is anticipated at the end-point.

The Decennial Pattern

The decennial pattern has connections with the average stock market returns, depending on the last digit of the year. According to the pattern, years ending with a 0 have historically been the worst-performing while those ending with a 5 have always been the best. In fact, market analysts consistently observed the pattern from 1885 until 1995. It took a 0.6% decline in 2005.

Reading 56 LOS 56f:

Explain how technical analysts use cycles.