Rick Ratchford

How Market Swings Come and Go

Market behavior is not due to random causes, but caused by market cycles which makes it possible to forecast future market turns.

Once the chartist discovers that the market swings viewed on a price chart are the result of non-random market cycles, of various frequencies and magnitude, an understanding of market behavior emerges. The next step is to use this understanding to exploit the historical patterns for the purpose of timing future trades.

Many who attempt to find these cycles by means of counting from one top to the next, or one bottom to the next, soon find that these discovered cycles fade into the woodwork almost as soon as they are discovered.

Why is that?

If a market's behavior were simply dictated by one single fixed-interval cycle, there would be no question as to where the next top and bottom would occur. In fact, everyone would know and thus no market could exist for a lack of individuals to take the other side of an obvious losing trade.

Fortunately, it is the fact that a number of different cycles exist at the same time, of different intervals (frequencies) as well as different magnitudes, that keeps the general populace from knowing exactly when the market will top or bottom.

As already hinted to, cycles contain both an interval (frequency) as well as magnitude (or amplitude). This is important to understand as I will explain now.

When looking at a price chart, the trained eye can instantly note that you have a series of wide swings as well as very quick smaller swings. And it is also evident that the smaller quick interval swings appear to be 'riding' on the wider swings.

This chart pattern is no different than what one would see looking at an oscilliscope displaying two or more cycles of different lengths and magnitudes combined.

What puzzles some who are new to understanding of market cycles is why you can follow a series of short-term swings for a period of time and then they appear to vanish into a very straight up or down move, with no swing within. To answer this, consider the following.

Each cycle makes a top or bottom at a specific interval, which is different than other cycles. In other words, each cycle has its own frequency.

When you combine these cycles, their respective tops and bottoms will form at different times. Because the times are different, at various times some of these may actually align (go in the same direction), thus combining their individual powers (magnitudes), making for a 'propelled' move. At these times, depending on the combined magnitudes of the cycles that have aligned to overwhelm the opposing effects of other cycles, you will see acceleration moves with the current trend and even gaps.

At those time periods where several cycles tend to align in the same direction, they can often overwhelm the shorter-term swing cycles to the point that the only evidence they are there is the existence of 'pause' bars.

A 'pause' bar is a price bar that makes an extreme, is followed by an inside bar (a bar that makes a lower high and higher low in comparison to the previous price bar), and then the extreme price is exceeded. At first glance, it looks like a bar that tried real hard to become a short term swing top or bottom, only to fail due to a very strong trend in play.

The market cycle analyst may determine in advance a series of short-term future dates when the potential for a swing top or bottom is high. Yet, if the dominant cycles have aligned in one direction, a very powerful trend move will likely occur and any short-term cycle turn expected within the time period covered by that aggressive trend move may fail to materialize. To the untrained observer, it would appear to be a failure in the analysis. In reality, the short-term cycle may in fact have been properly analyzed and reported, but simply overtaken by the combined powers of several cycles currently moving in the same direction that would oppose any minor cycle moving in the opposite direction. Thus, no swing would likely be visible, or barely so.

Unless the analyst can determine the individual cycles, each with their own frequency and magnitude, and how each aligns to one another (the phase), the analyst will simply have to live with the minor inconveniences of periodic swing failure. Having a good trading plan on how to deal with such situations goes a long way to lower the negative effects of not being 100% accurate in forecasting every single swing top and bottom.

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