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.
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.
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.
The Nasdaq crossed below its 20-week FLD this week, creating a projection down to around the 2600 level.
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)
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.
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:
Bonds are still playing by the rules, and we are seeing the expected push up into the 80-day cycle peak.
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.
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.
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!