I use cycles as a road map, to do this I apply what I call my theory of relativity, it is based on the premise that there are multiple cycles in effect all the time and each cycle is subservient to the next larger cycle. For example in the chart below I have shown 3 key cycles, the largest being the 4 year (presidential) cycle, the 1 year cycle, and a 4 month (red bars) cycle, there are many more cycles but for today's purposes these will do. Notice how during the past 20 years, the 1 year cycle (blue dots) has not gone below the previous 1 year low unless the dominant 4 year cycle has turned down, in fact on only 2 occasions, one being the drop into the 2002 low and again just recently (red circles), did we see a break of a previous 1 year low at all!
Simple enough so far, easy money, but wait, there are flies in the ointment that make trading solely using cycles notoriously difficult, notice that the 4 year's cycle lows are often consistent, this is normally the case, but the highs are more erratic, this is called early, normal or late translation.
Also notice that there is often more than one low formed during each year that can be the 1 year low, it can come in early or late, leading one to question, where the heck are we. The thing that really has hair on it, is that a cycle can shift, some say it can skip entirely, but providing it acts like a low and rallies convincingly from it, I usually assume it did come in but was of a smaller amplitude than normal, the lows in 1994 and 2006 are excellent examples of this.
Looking at the above chart we see the current dynamic, after making a double top, we went down, first breaking though a recent 4 month low and then surpassing all the lows of 2007. So we had broken the previous 1 year low, this showed that the 4 year cycle had turned down. Next we made a low in march of 08 which we can label as a one year low, also notice we made another low 4 months later, which at the time could also be labeled a 1 year low, in fact many analysts were calling for a bottom at that time. When that 4 month low was broken, the bottom fell out, we took out the 2002 low, then another 4 month low triggered a bounce, finally we made the low in march of 09, one year from the last low in march of 08, when the 1 year low and the 4 month low both bottomed together (in cycle terms this is called nestling, they all bottom together)
Everything was fine up until then, a rally was expected from that point, the market was extremely over sold, we had all our ducks lined up and pow, the rally began right on schedule. As you can see from the chart we made an important 4 month cycle low in July, at that point many were seeing a head and shoulders top and expecting a new low, from there we rallied strongly to where we are today.
Darn, there is hair on it
OK that is all well and good, but what now? Here is what should happen, if everything goes like clockwork we should top out very soon and then drop sharply for the next 4 months, take out last year's low and make the next 4 year, 1 year and 4 month low in March. However things have gotten a little fuzzy, the most obvious problem is that it almost seems impossible to fall that far, that fast, also we have gone up longer than the 1 year cycle should, you see late in a 4 year down trend, the 1 year cycle should translate or turn early, not go up for eight or nine months, plus we just made what I believe is 4 month low and are still going up. As a trader, it has been my experience from watching shorter term cycles, that if a cycle shifts, it does it after a larger than normal move, which we have seen.
In the above chart I have shown the 4 month cycle, that has been so tradeable, I believe it has bottomed and is on its way back up, this is very clear on the Transports and the NASDAQ.
I have also included potential targets generated from the head and shoulders pattern and the measured move theory (NYSE:ABC). Keep in mind that we can turn back down any time, giving an early translation. A break below the last low would be lights out for this rally, in fact any weakness now will be a negative, after this break out of the highs we should bolt up. The question is when we do turn, can we go to a new low, anything is possible, there are a plethora of fundamental reasons for another panic, but one thing is clear, when this 4 month cycle tops, we could have 3 cycles pulling us back out of orbit, that is providing the 4 year cycle hasn't shifted. For now I continue to pick up nickles in front of the bulldozer, but I am wearing my running shoes. Next time I will look at the key cycles in gold.
©2009 Bob Clark