This article is a follow-up to our series Introduction to Cycle Analysis. If you have not yet read that, we strongly suggest you do so before continuing on here.
In the precursor series to this article, Introduction to Cycle Analysis, we focused on building a foundational understanding of cycle analysis. When looking at charts, we focused on projecting in time and price in the short-term for one particular security. The charts we saw contained cycles that were pretty clear to see, with “troughs” that were not very ambiguous.
For this article, we are going to take a step back and see how cycle analysis can be used from a high level, on a longer timeframe, to reveal overarching market trends, even when the beginning and end of the cycles are not always clear. We will dive deeper into some cycle analysis concepts that were already mentioned in Introduction to Cycle Analysis, and we will also introduce and explain a few new terms. This is very powerful stuff, and learning it well is guaranteed to enhance your view of the market.
I Trade On a Short Time-Frame, Is This Still Relevant to Me?
In short, yes. The end goal of technical analysis is to establish a methodology that increases the probability of accurately projecting market behavior. By gathering technical information from multiple time frames, we better our chances of making accurate projections. Knowing this, a short-term trader can still very much benefit from knowing what the current intermediate and long-term trends are.
There is also a new concept we will introduce here, called Periods of Risk, that we think you should understand regardless of your trading timeframe.
What are “Periods of Risk”? How Do They Relate to Cycle Analysis? Why Do They Matter?
As a reminder, cycle analysis is such a powerful technical methodology because it allows us as technicians and traders to have a higher probability of accurately projecting in time, price, and direction. Within the context of cycle analysis, a “period of risk” is a timeframe in which the ability to project in price becomes less precise because of the likely sharp increase in volatility. When performing cycle analysis, we very often see periods of risk directly coinciding with cycle low timing windows.
Cycle low timing windows result in volatile “periods of risk” as there is typically significant downside risk from the impending cycle low while, simultaneously, there is upside risk that sets in when the low has formed and the new cycle begins.
All types of traders must understand this because periods of risk transcend your trading timeframe. That is to say, if a weekly chart shows that a security is within a period of risk, the expected volatility will likely affect price action on daily charts as well.
What We Will Cover in This Article (Click Links for Shortcuts):
- Interpreting Simple Moving Averages and the Reversal Scout
- “Swamped” Cycles
- Identifying Cycle Bottoms When They are Unclear
- Discovering Valuable Information by Comparing Actual Cycles to Ideal Cycles
- Analyzing Cycle Configurations and Cycle Translations to Unlock New Information
- Fundamental Analysis and Visualizing Periods of Risk
Interpreting Simple Moving Averages and the Reversal Scout
Above we see a weekly chart of SPY, showing data from April of 2020 until July of 2022. The black and blue lines demonstrate the 13-week and 34-week Simple Moving Averages, respectively. A few key takeaways on the 13 and 34-week SMAs:
- When the 13-week SMA is above the 34-week, it’s generally a positive condition.
- When the 34-week is above the 13-week, it’s generally a negative condition.
- The 13-week SMA often acts as a point of support or resistance.
The green(positive momentum) and purple(negative momentum) line on the chart shows the askSlim Reversal Scout Momentum Indicator. Besides showing a security’s momentum on a given timeframe, the Reversal Scout is also very handy for helping us to identify cyclical patterns.
Take a look at the chart above and try to indicate where the cycles begin and end. It’s a little unclear at this point, right? As we will see, there are times when a slight change in the reversal scout is one of the only clear indications we get that a cycle has bottomed, which makes it an invaluable tool for performing quality cycle analysis.
“Swamped” Cycles & Identifying Cycle Bottoms When They Are Unclear
In this chart, we’ve expanded our analysis to include the “ideal cycles” and the “actual dominant cycles”. The ideal cycles for this particular timeframe are shown by the half circles on the bottom of the chart – the large ones representing the “dominant” cycles (26 weeks) and the smaller ones showing the “minor” cycles (13 weeks). As a reminder, the ideal cycles are simply benchmarks for the standard market cycle; they do not perfectly predict the price action of a security.
The actual dominant cycles are shown by the diagonal lines above the candlesticks. Clearly, some of the actual cycles look far off from the ideal. For now, let’s focus on the first three cycles on the left. In each of these cases, a cycle bottom is unidentifiable, as there is either very little measurable decline or none at all. The terms we use in cycle analysis for this sort of behavior are “invisible” or “swamped”.
In cycle analysis, “swamped” means the security used up most of (usually 70% or more) the cycle rallying or declining.
So if the cycle bottom is nearly unidentifiable, how can we still find it? For starters, knowing the average cycle length for the given timeframe (26 weeks in this case) provides confidence that a cycle bottom is likely to be occur around a certain date. Additionally, we can take advantage of the Reversal Scout! In two of the first three cycles in the chart above, you’ll notice that the Reversal Scout turned from green to purple just as the cycle bottom was forming, even while the overarching trend was positive.
Discovering Valuable Information by Comparing Actual Cycles to Ideal Cycles
Here we’ve added the actual minor cycles, shown as the “half cycles” inside of the dominant cycle and as diagonal lines just above the candlesticks and below the actual dominant cycles. We’ve also added the dominant cycle lines, shown by the blue vertical lines.
The main thing to understand about minor cycles is that we analyze them in the exact same way as with dominant cycles, except they are on a shorter timeframe.
The dominant cycle lines show us where the dominant cycle actually bottomed, as compared to what we expected based on the ideal cycle brackets. Comparing actual cycle bottoms to the ideal can be very useful. A couple general rules for this:
- In a rising market, we will often see cycles actually bottoming before the ideal cycle was projected to bottom
- In a declining market, we will often see cycles actually bottoming after the ideal cycle was projected to bottom
Analyzing Cycle Configurations and Cycle Translations to Unlock New Information
The new additions on the chart above include a couple new concepts, Cycle Configurations and a Head and Shoulders Top, as well as Cycle Translations, which we touched on in Introduction to Cycle Analysis.
For now we will focus on the Cycle Configurations, Cycle Translations, and how to analyze them in conjunction, as they are concepts which are unique to Cycle Analysis.
The Cycle Configurations are represented by the large green and red arrows in the chart above , with green arrows showing that the cycle is “positively configured” and red arrows showing that a cycle is “negatively configured”.
- A cycle is positively configured if it marks higher lows than the previous cycle
- A cycle is negatively configured if it marks lower lows than the previous cycle
If you recall from Introduction to Cycle Analysis, we introduced the term “translation” in the context of cycle analysis. As a reminder:
- When an actual cycle “peaks” before the peak of the ideal cycle, we call that a Left-hand Translation, as it peaked to the left of the ideal cycle peak. Left-hand translations are generally bearish indicators.
- When an actual cycle “peaks” afterthe peak of the ideal cycle, we call that a Right-hand Translation, as it peaked to the right of the ideal cycle peak. Right-hand translations are generally bullish indicators.
In the chart above, you’ll see that the first three cycles are positively configured and each has a right-hand translation. When considering cycle configurations and translations side-by-side, we see a couple common patterns:
- A cycle that is positively configured and translated to the right gives us a strong indication that the next cycle will likely mark a new high.
- A cycle that is negatively configured and translated to the left gives us a strong indication that the next cycle will likely mark a new low.
Since cycle analysis is our chosen strategy at askSlim.com, most of our time is spent technically analyzing charts to gain more information. Nevertheless, when fundamental factors such as intense government stimulus strongly affect the market, we pay attention to that information too. In the same way that a short-term trader can still benefit from understanding intermediate-term trends, a technical analyst can still benefit from understanding fundamental factors which will affect the market.
The other new additions to this chart, periods of risk, are shown by the yellow ovals. As you can see, periods of risk occur when a cycle is in the timing “window” of the expected low or bottom. You’ll notice on the chart above that there are often visible sharp moves in price that occur within these periods.
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To learn more about the askSlim Method of performing Cycle Analysis, you can read our series, Introduction to Cycle Analysis.