The Dominant Cycle – 13 October 2012 17


The markets did just what was expected of them this week: they surrendered to the Bear. I spent the week fishing in the Sibillini mountains in Umbria (Italy), and so I had ample time to think of new ways to examine the markets from a Hurst perspective instead of simply repeating myself as our analysis plays out as expected. And so if you haven’t been keeping up with your Hurst Cycles Outlook please read our back-issues, as all of the above still applies!

Today I would like to focus on one of the interesting comparisons between the cycle theory that results from Hurst’s Cyclic Principles and any other cycle theory, which is the concept of a dominant cycle.

Other cycle theories generally identify a dominant cycle  as a cycle that is revealed by a mathematical process to have a greater amplitude than any other cycle in recent price action. The mathematical processes are generally some form of spectral analysis and have awe-inspiring names like Fourier Transform, Hilbert Spaces, Dirichlet Forms, Barlow-Evans Fractals, Laakso Spaces: names which give me shivers of fear and confusion (so much confusion in fact that I think you’ll find they aren’t all strictly speaking forms of spectral analysis!) The point however is that a dominant cycle is extracted mathematically from the data, and the wavelength of that cycle is often calculated to great precision.

The problem with this approach is that no sooner have you calculated the wavelength of the dominant cycle, and it disappears! I have used several cycle analysis software programs which take this approach to identifying cycles in the market, and I have found that it never seems to work (which is why I finally set about creating Sentient Trader for myself).

The big problem with trading on the basis of a purely mathematical analysis of financial data is that it doesn’t assimilate the true nature of cycles in financial markets, which is that there are multiple cycles working together in an imperfect manner.

The reason that so many non-Hurst approaches experience cycles that disappear as soon as they have been identified, or which are “unstable” is because they ignore the impact of other cycles in their attempt to reduce the markets to a single golden number – the wavelength of the dominant cycle. That single golden number will never pave the road to riches, no matter how much mathematics you throw at it.

How is Hurst different? Because Hurst’s Cyclic Principles acknowledge the “real-life” nature of the markets: multiple cycles are at work all the time and they are pushing prices up and down in an imperfect manner. The result is a record of price movement which provides us with clues as to what the various cycles are doing. Clues to which we need to apply our advanced human brains. We then discover that cycles never disappear. They might suffer variations in wavelength and variations in amplitude, but they are always there.

So what is the connection with the Dominant Cycle? Hurst also defined a dominant cycle, and many people who come to Hurst after a weary journey through other cycle theories confuse Hurst’s dominant cycle with the dominant cycle of other theories. Yes, Hurst’s dominant cycle is also the cycle that has recently been of greater amplitude than other cycles, but Hurst’s dominant cycle is much simpler: it is very simply the longest “visually apparent” cycle on the chart. It is not determined mathematically, but visually. The other thing that happens with Hurst’s dominant cycle is that it keeps changing. It is not a matter of the dominant cycle disappearing (as in other theories), but the dominance shifts between the cycles in the nominal model. Of course trading the dominant cycle is a good idea, but because the dominant cycle changes, it can result in a constant process of chasing the dominance from one cycle to another.

This shifting of the dominance from one cycle to another has always fascinated me. In my early days as a “Hurstie” I tried chasing the dominant cycle before realizing the futility of that process. I did learn something interesting however: as a market undergoes a turning process, particularly when forming a peak, the dominant cycle tends to shorten as the longer cycles slowly tip over.

This week as the markets continued to describe the perfect M-shapes that I wrote about last week, this shortening of the dominant cycle became apparent in many of the markets we follow, and my conviction that we are going to see further downside deepened because of this.

Hurst published charts of 180 bars, on which he would identify the dominant cycle and so today I will do the same thing.

S&P 500

A quickening rhythm

The dominant cycle in the S&P 500 looks fairly obviously at least 20 weeks in length, but you can see how recently the 20-day cycle has become particularly prominent, because of the formation of the top of the M-shape discussed last week. We are expecting the 20-week cycle trough to form soon, but needless to say, this chart is not looking particularly bullish just yet.

Nasdaq

Last week I pointed out the Nasdaq’s bearish cycle shape, and this week the tech stocks led the downwards move. The dominant cycle here too is clearly the 20-week cycle, but notice the shift of dominance to the shorter cycles after the June trough, and more recently surrounding the September peak.

Leading to the downside

The Nasdaq crossed below its 20-week FLD this week, creating a projection down to around the 2600 level.

Euro/US Dollar

The Euro has been beating to a slightly different rhythm and the dominant cycle here is arguably the 80-day cycle. Notice here too the quicker beats recently, and following the July trough. (Or perhaps the recent quickening has simply been the anticipation of a Nobel Peace Prize)

A shorter dominant cycle

Gold

The dominant cycle in Gold is much longer, at well over 30 weeks so that our 180 day chart shows only a part of the cycle. Gold didn’t manage to push higher this week, and the peak of last Friday 5 October 2012 looks very likely to be the peak of the 40-week cycle that we have been waiting for.

Near perfect FLD projection

Note how the price projection generated by the price crossing of the 40-week FLD proved to be very accurate (if you adjust the crossing level for the slightly complex cross that occurred the accuracy could be even greater)

If you still believe in the idea that Gold goes up when stocks go down, now might be the time to confess it (and reconsider).

30 Year US Bonds

On the other hand Bonds have a much shorter dominant cycle, of only 40 days:

A 40-day dominant cycle

Bonds are still playing by the rules, and we are seeing the expected push up into the 80-day cycle peak.

Crude Oil

Oil has very sensibly teamed up with the Nobel Peace Prize winner (or collaborator of the winner) this week and has the same dominant cycle of 80 days. The bullish move this week against the backdrop of so many other falling markets tilts the odds in favor of the analysis discussed last week, although that 40-day trough in mid August still bothers me. I will be keeping a close eye on Oil in case of any signs of weakness, indicating that the 80-day trough is a straddled trough as discussed last week.

An 80-day dominant cycle

US Dollar Index

The US Dollar has a deceptive dominant cycle when we look at only the most recent 180 bars. If I was doing the analysis manually I would go for the 80-day cycle, in line with the Euro. Notice that the 20-day cycle has been prominent recently as it has in most other markets. This might be in reaction to the recent 20-week cycle trough, but I am still bearish the US Dollar in the medium term (the next 9 months at least), and so we might be seeing the early formation of a peak.

80-day or 20-week dominance?

One of the questions we are asked most often is “which cycle should I trade?” The answer to that question is in some ways more complicated than it might sound at first, but actually I believe the best approach is the simple one: choose one cycle and then stick with it! Don’t try to choose the dominant cycle because it will change. But make sure you do know which cycle is dominant, and how it relates to the cycle you are trading:

  • If the dominant cycle is the cycle you are trading then trading will be fairly easy.
  • If it is longer than the cycle you are trading then you need to be nimble getting into your trades, and once you’re in there hold on tight for the ride that the dominant cycle will take you on.
  • If the dominant cycle is shorter than your trading cycle then consider not trading at all: the whipsaws can be vicious.

Thank you to everyone who answered our questions about trading Hurst Cycles last week. We will have an announcement to make later this week, so stay tuned!


About David Hickson

I have been trading for over 20 years, but only had any success after discovering Hurst's cyclic principles. Unable to find any software to speed up the analysis process I created Sentient Trader software, which now pretty much does all the analysis for me. I am a film maker and a TV director, but nowadays I mostly provide consultation services to professional traders and fund managers, helping them to integrate Hurst analysis into their trading. I'm South African and live with my family in Italy.


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17 thoughts on “The Dominant Cycle – 13 October 2012

    • Jeffrey Young

      So why is the analysis unclear? I think David is very clear without telling you exactly when to trade? WHen you make blamket statements like that without expressing a need or direction it makes little sense other than criticizing which makes the communication confusing and probably unnecessary. You your skills and decribe what you need please and then maybe all of us can learn.

  • Arthur Kazantzis

    Hello David,

    I find your blog very interesting and useful. I wanted to ask: with both the stock markets and the dollar falling into an 18 month trough in the December-february period, are you expecting broadly sideways movement in the main capital markets until then?

    AIso, I see that you say (this week) you are bearish the dollar over the next nine months, although surely the dollar should move up strongly from the forthcoming 18 month trough, pushing the main asset markets down (as the dollar rises) into the next cyclical bear market? Or are you expecting it to put in several months of basing sideways movement as it did in 2011?

    Regards,

    Arthur Kazantzis.

    • David Hickson Post author

      Hi Arthur
      I’m delighted to hear you find the blog useful. Your question is a fascinating one, and has had me thinking for some time. Yes, I think I would expect the capital markets to move sideways as suggested by your reasoning, but the truth is I am finding it hard to think my way out of this! Your question has made me realize how much of a “chartist” I am – show me a chart and I will give you an answer, but when it comes to reasoning through the relative value movements of different markets without reference to a chart I confess to finding it hard to give any answer at all! Thank you for exercising my mind on that one!
      In answer to your second question, no I don’t expect the dollar to spend several months moving sideways as it did in 2011. I expect it to bounce up out of the early 2013 trough, and I wrote nine months hastily and in error. I do expect the approaching trough to occur late (because it is a trough of a very long cycle in my opinion) and so the calculation is actually: we are in the last 20-week cycle, which is about 5 months, and I expect the trough late, so make that six to seven months of bearishness, not nine months.

  • William Randall

    All technical analysis uses “mathematical processes” of one form or another. The issue is not whether the process is “purely mathematical” but whether it is accurate.

    The problem is the use of the term “cycle.” Most non-Hurst methods use it in the trigonometric sense, i.e. a sinewave with a particular angular frequency and amplitude. A Hurst “price wave” is NOT an individual frequency! Hurst clearly states that the dominate prices waves consist of a band of such frequencies. The mathematical complexity is increased by the fact that each component in the band is modulated.

    In the early 70’s when Hurst published his cycles course it would have impossible for the average trader to do such calculations without the use of a multi-million dollar mainframe. Today however anyone with the requisite math skills can do them on a $600 laptop!

    The continued applicability and accuracy of Hurst’s bandpass filter approach to extracting prices waves is easily shown by using the filter paramenters he laid out for extracting the 4 year wave in Profit Magic and apply them to the U.S. indices from 1900 (or earlier with respect to the S&P 500) to today. I highly recommend it because an extremely accurate custom nominal model can then be constructed and applied in ST.

    William

    • David Hickson Post author

      Hi William
      There will always be a healthy debate between the analysis approach that Hurst presented in the Profit Magic book and the approach presented in his Cycles Course. I have always found the less mathematical, pattern recognition approach presented in the Cycles Course works best for me, but it is good to hear from an advocate of the other approach. Good also to hear that you are able to use Sentient Trader to apply the results of your research!

  • M Schroeder

    Many cycle concepts have us at the ends of Mega Cycles, T THeory, Peter Elaides, etc. Yet in Hurst we are just moving through the lattest 4.5 to 6 yr cycle with 18 mo subcycles etc.

    What is the “Hurst” Sentient trader larger picture, say to 2016 a popular cycle climax, or does it not exist – Sentient only being a short term, 6 mo or less, backlook and 1 mo if that outlook.

    How does Hurst fit into managing a portfolio? vs just short term trading?

    • David Hickson Post author

      That is a great question – in the next few weeks I will take a step back and look at the longer term Hurst picture. The only reason I am discussing the shorter cycles and timeframes here is because they are the ones I find most interesting, and which I hoped would be of interest to our readers. One can use Sentient Trader to look at a much longer picutre, which I will do here soon. Finally I believe Hurst works very well for managing a portfolio, particularly because one can analyze the relative values of several instruments, and determine how the cycles are affecting those relative values.

  • Jeffrey Young

    Hi David,

    I have two questions. The first is what is a straddled trough? Can you show some examples and second how does that affect trading decisions. Another thing when I am analyzing some commodities there are two boxes directly above and below each other one calling for a top and the other a bottom but pretty much within the same time frame. Now I tend to stand aside in those situtions but could you explain why they occur.

    Each week you are emphasizing some excellent perspectives that I find very useful and I really appreciate the information. Right after I read this week the visual presentation of cycles started taking on a new meaning as I am now able to see the different cycles and start forming an interpretation based on what I am visually seeing especially with the semi-circles. I think part of what is the key is waiting for the right setup and letting marginal trades just pass by. Thanks for the great work.

    • David Hickson Post author

      Hi Jeffrey
      I’m delighted to hear that the cycle shapes are making sense, you are absolutely right that the key is waiting for the right setup. Sometimes the best trade is no trade at all! In answer to your questions: a straddled trough is one which is less impressive than it should be when considering its magnitude. It is the middle trough of the “M”. I wrote more about it in this post.
      When two projection boxes are right on top of each other as you describe it indicates that the projections for the cycle moves are pretty much overlapping. I think of it as the cyclic picture is not clear enough. The markets aren’t perfect, and sometimes there is simply too much noise or uncertainty to be able to generate a clear projection.
      Thank you for your encouraging comments!

  • Jeffrey Young

    David,

    I was surprised this week by the magnitude of the rally. I expected the levels we are at today but figured we would not arrive at these levels for another 3-4 trading days when I expect prices to reverse again into tan end of month low. Maybe we are not going to get the downward magnitude I had expected of the 80 day trough? As price is only 10 points or so from its yearly high the possibility of price moving higher has increased even though I do not feel that is supported by the cyclic picture. Your thoughts?

    • David Hickson Post author

      Hi Jeffrey
      Yes indeed I was also surprised by the sudden strength this week. It looks very much to me as if the 20-week cycle trough has arrived, which would create such a strong push up, but the whole thing still looks very much like the formation of a complex peak to me, and so I don’t expect to see 10 weeks of bullish follow-through (as in half the 20-week cycle). As you suggest we could see a higher peak, but it is all still part of the formation of a complex peak, and of course (like pride) peaks are always followed by a fall. Lots to discuss this weekend!

  • Jeffrey Young

    Hi David,

    Okay, I am confused tonight or I should say searching for answers. It appears that the 80 day cycle low shifted from August 23rd back to July 25th and other dates of course. This is a huge shift and totally where before the 80 day cycle was straddling the 20 week cycle but now is in line with itat the Sept 20th bottom. The whiskers were so perfectly lined up for an 80 day trough near October 29th now that synchronization has totally disappeared. This reminds me of last month when the consolidation kept shifting the trough back and forth. TH eonly thing I can thinkof is that maybe this means we will pushhigher. Please explain what is happening as you see it. WHy such a long cyclical shift? As usual thank you for any insight you can shed on this. I love this stuff its absoultely fascinating!

    • David Hickson Post author

      Hi Jeffrey
      It sometimes happens that there are two viable positions for a particular cycle trough. I have been presenting both options here recently, using the S&P 500 for the one option and the Nasdaq for the other. If you let ST do its own thing then you will see this shifting trough which can be disconcerting. I would recommend that as soon as you see this kind of shift you should create a new chart in your workspace and pin a trough at the alternate position, then watch the two analyses as they develop. Sometimes the analysis dilemma is quickly resolved, at other times it takes longer. When making trading decisions you have a choice: either only trade when both analyses suggest the same direction for price (which happens often, and is why people with different analyses will trade similarly), or stay clear of the market because of your uncertainty, or choose one and put your money on it!
      In terms of what is happening in the market at the moment, I have posted an outlook update this morning (20 October 2012) which presents my view.

  • Jeffrey Young

    David,

    I posted a question last night about compression of the 80 day cycle and its shift and the fact that this perfect syncronization of a trough at the end of October had just disappeared. It appears that my post did the same thing it disappeared. I was wondering how that extreme shift happened? Then today was crazy. Did not expect this at all. As I mentioned previously time symmetry concepts saw a top on Monday at the earliest. Kust some guidance and direction. I am learning every time something like this happens.

    • David Hickson Post author

      I confess to being a bit obsessive when it comes to symmetry. As a TV director I used to insist that sets were symmetrical, camera shots symmetrical, logos symmetrical … the market has helped me overcome this obsession, because the symmetry is often not perfect.