MARKET CYCLES

Introduction

Cycles are extremely important because they help us frame the market within the
dimension of time. I was led to cycle studies by people whose work I respect, not the
least of whom was Stan Harley (The Harley Market Letter; 805-484-4258), Timer
Digest's 1998 Timer of the Year. Stan's work with cycles is not entirely unique, but
he understands cycles as well as anyone I know, and he has been very helpful to me,
both in my research to understand cycles better and in the preparation of this article.

I should also emphasize at the outset that this article represents my own interpretation of
of what I have learned from others. The concepts are not altogether original, and I
certainly give credit to those who have pioneered them; however, my conclusions may
differ significantly from those of other cycle proponents. In other words, this is not
necessarily the last or best word you will read on the subject.

The first thing we should do is ask what cycles are. This is not an easy question to
answer, so let's just say that cycles are the observable tendency of prices to arc from
trough (bottom) to trough at regular intervals. The price index will move upward from one
trough until it reaches a crest (top), then the price index arcs downward into the next
trough, or cycle low, as we sometimes refer to it. We can see the evenly spaced bottoms
on the price chart that give evidence of the existence of cycles, but what causes this to
happen? What is the cyclical force behind the price movement?

A stock market chart is a picture of human emotions expressed in the form of price
movement. Fundamental events don't directly move stock prices, it is the emotional
reaction to those events that moves prices. In a much broader context there are
recurring events in nature and in the business cycle that affect human emotions. In other
words, natural and fundamental events do affect the market, but only through the filter of
human emotions. This is why it is so difficult to design economic or market forecasting
models based on fundamentals -- humans can react quite differently to the same
fundamental circumstances at different times.

The Foundation for the Study of Cycles has catalogued about 20,000 cycles. One of the
most obvious and observable is the circadian cycle, the change from day to night to day,
which is caused by the rotation of the planet (or the rising and setting of the sun,
depending on your point of view), but, since it is only one of 20,000 cycles, it is obvious
that cycle study is much more complex than we might like. We can observe recurring
cycles in price movement, but we should remember that the "force" behind the cycle will
manifest itself differently in each cycle, and, while we might expect a significant price low
at a scheduled cycle bottom, it may not play out the way we originally forecast it.

Since a picture is worth a thousand words, let's look at an idealized illustration of

Nominal Market Cycles below, a concept I am borrowing from my friend and mentor
Kennedy Gammage (The Richland Report; 858-459-2611). Here we can see how cycles
would look if they were perfect. There are two 10-Week Cycles within one 20-Week
Cycle, two 20-Week Cycles within one 9-Month Cycle, and so on. Where cycles of
different lengths make their lows at the same time, they are said to be "nesting".
The most compelling thing about this picture is the impression of power associated with
major nesting points -- where all cycles are making lows at the same time at the 10-
Week, 20-Week, 9-Month, 18-Month, and 4-Year Cycle lows. Visually we can sense that
price declines into these major lows will be quite severe, while rallies off those lows will
be explosive and powerful. Conversely, there other areas in the cycle structure where
the cycle forces are mixed, with some cycles moving up while others are moving down,
and it is hard to get a sense of exactly which direction a composite of these cycles would
be pushing the market.

I have begun to think of cycles in terms of being a rising and falling of emotional energy
caused by natural and fundamental conditions and events. While it cannot be quantified,
we can imagine it as being something like the currents in a winding, fast moving river.
Sometimes we can observe the currents on the surface, twisting and turning, combining
with other currents and becoming stronger, splitting apart and becoming weaker, then
submerging and disappearing completely, only to reappear again further down stream.

When applying this concept to price cycles, we can be a little more open-minded and
cautious in our expectations of the cycles we are following. Sometimes we will be able to
see the cycle quite clearly, and other times it will disappear. Sometimes it will behave in
a predictable manner with the down side of the cycle resulting in price declines and the
up side of the cycle resulting in price advances, while other times price movement will be
quite different than we had anticipated. In other words, cycles are useful, but they are
treacherous. Use them with care.
Cycle "Translation"

You will often hear reference to a cycle's "translation". This refers to the fact that cycles
rarely crest in the exact center between troughs. More often they will crest to the right of
center, called a "right translation" cycle, or to the left of center, called a "left translation"
cycle. (This has to be something an engineer dreamed up. Wouldn't it be easier to say
the cycle "leans" to the right or left? Maybe not, because then everybody would know
what it means.)

In a bull market the market spends more time going up than down, so we will normally
expect major cycles to crest toward the end of the cycle, with the crest being followed by
the down phase of the cycle -- a right translation. Note in the illustration below that a right
translation also means that the cycle trough after the crest will normally be higher than
the trough at the beginning of the cycle.

In a bear market we would expect to see left translation cycles with cycle patterns exactly
the opposite of those in a bull market.
Rules Regarding Cycles

Rule 1: Price movement is a manifestation of cycle forces, not the cycle force itself. When
we refer to a cycle, we are technically referring to an invisible psychological force driving
the price moves we can observe on the chart, but we will most often describe the cycle in
terms of price movement because that is where we can normally see the cycle force at
work; however, there are times when the evidence of cycle movement will be easier to
spot by reference to an internal indicator.

Rule 2: A cycle low is not always found at the price low for the cycle. This is just an
extension of Rule 1, and it is a reminder that we are primarily trying to identify the point at
which cycle forces change directions

and begin moving upward into the next cycle. We will use various methods to do this, so
remember not to get confused when the price low and the cycle low are miles apart.

Rule 3: Cycles can expand and contract at will. We project cycle lows based on
averages, but we always have to be alert for changes in the expected length. The
variability of cycle length can be so extreme that the number of subordinate cycles within
a greater cycle can change. For example we might find three 10-Week Cycles within a
20-Week Cycle.

Rule 4: A cycle of greater magnitude will truncate the length of subordinate cycles. The
best example of this is the two 20-Week Cycles within the 9-Month Cycle. The phase one
20-Week is usually longer than the phase two 20-Week, which is normally shortened by a
9-Month Cycle making its lows on time. In other words, a 9-Month Cycle does not expand
to accommodate a lengthening 20-Week Cycle.

Rule 5: Cycle length is a "nominal" identification based on averages. If you do the math,
you will find that there are 5.3 9-Month Cycles within each 4-Year Cycle, yet we only
depict 5 because it is simpler to work with the averages.
The 9-Month Cycle

The most important cycle in my work is the 9-Month Cycle. The 9-Month Cycle goes by
other names -- the 40-Week Cycle, the 39-Week Cycle, and the 8.6-Month Cycle, to
name the ones I can think of at the moment. A lot of people follow it, and it is, I have
come to believe, the most important cycle for use in intermediate-term market
forecasting, because it helps us plan for and quickly identify the most important declines
and rallies that we will encounter within the course of a year. Even if you are a short-
term trader, it is essential that you be aware of the progress of the 9-Month Cycle so that
you will be in tune with next higher trend.

The illustration above shows the basic structure of the 9-Month Cycle. As you can see, it
consists of two 20-Week Cycles, labeled as "Phase 1" and 'Phase 2". Likewise, the 20-
Week Cycle consists of a Phase 1 and 2 10-Week Cycle.

The most powerful rally during the 9-Month Cycle will normally occur during the first
three months of the cycle as all three nesting cycles are combined in a united upward
move. Conversely, the period when the market is most vulnerable to a significant decline
is during the last three months of the cycle when all three cycles are moving downward
together into their final troughs.

In a bull market the 9-Month Cycle crest normally occurs in the sixth to eight month in
the cycle (right translation), and in a bear market the crest should be expected in the
second or third month of the cycle (left translation).

In addition to the cresting of the 9-Month Cycle, the next most significant event is the
cresting and completion of the Phase 1 20-Week Cycle. This can materialize as a minor
price correction or consolidation in a bull market, but in a bear market it will likely
coincide with the cresting of the 9-Month Cycle.

Knowing this basic 9-Month Cycle structure, we can consider that we are at the least risk
establishing new long positions during the first three months of the cycle, and the
greatest risk of decline comes in the last three months of the cycle. The three months in
the middle is a time when caution should be exercised -- it can present risk as the Phase
1 20-Week Cycle rolls over into a trough, and it also can present new opportunity as the
Phase 2 20-Week Cycle begins to move up.
Real-Life Examples of the 9-Month Cycle

The chart below shows examples of 9-Month Cycles -- the beginning and end of the cycles is marked by the dotted red lines. Of
the three complete cycles shown only the first (January to October 1998) is what I wwould call a perfect example of a 9-Month
Cycle. The two cycles that follow are two of the worst examples I have ever seen, but they do serve to illustrate the difficulty of
working with cycles.

Another concept illustrated by this chart is how to use technical indicators to identify or confirm cycle lows. For example, the
October 1998 low was confirmed by a beautiful positive divergence on both the ITBM and ITVM -- higher oscillator bottoms
associated with the double bottom on the price index. In February 2000 the cycle low was confirmed by relatively oversold
bottoms on the ITVM and ITBM.

Some may disagree with my designation of a 9-Month Cycle low in June 1999, but I decided to adhere to the nominal cycle
schedule, which was more or less confirmed by a series of short-term bottoms on the ITBM and ITVM, and by its location
between the easily identifiable October 1998 and February 2000 cycle lows.
What we have presented is a structure or paradigm within which we can approach analysis of cycles in real time. It is not carved
in stone, and you have to be flexible in your approach to cycle analysis -- more or less turn down the left brain and use right brain
functions of creativity and intuition. Remember, there are two primary objectives:

(1) To identify the 9-Month Cycle low as soon as possible because it represents the best buying opportunity in the entire nine
months; and
(2) To correctly identify the crest of the 9-Month Cycle because it is from these tops that significant market declines normally
begin.

We accomplish these objectives is by tracking subordinate cycles and other market indicators.