Chapter 8 - Time Cycles

Question 1

What is amplitude?

Answer 1

The height of a wave in cycle analysis; calculated as the difference between the
wave’s peak and the wave’s trough.

Question 2

What is a decennial pattern?

Answer 2

Edgar Smith’s description of the stock market over a ten-year cycle; years ending
in a 2, 4, 5, or 8 tend to be strong, while years ending in 1, 3, 6, 7, and 0 tend to be
weak.

Question 3

What is harmonicity?

Answer 3

In cycle analysis, the principle that adjacent cycles are often related by small, whole
numbers; for example, the next larger cycle might be twice the length of the shorter cycle.

EXAMPLE: If we’re considering a 9 month cycle, the next cycles we might consider would be the 4.5 month or 18 month cycles.

Question 4

What is the January effect?

Answer 4

The tendency of all markets to end the year higher if prices rally in January, or end the
year lower if they decline in January.

Question 5

What is the Jugular cycle?

Answer 5

An observation by Clement Jugular that interest rates follow a 9 to 11 year cycle in
four phases: prosperity, crisis, liquidation, and recession.

Question 6

What is the Kitchin cycle?

Answer 6

An observation by Joseph Kitchin that economic statistics follow a 40-month cycle; further study indicates that the cycle can range between 40 and 53 months.

Question 7

What is the Kondratieff Cycle?

Answer 7

An observation by Nikolai Kondratieff that capitalist economies follow a 50 to 60 year (average 54) cycle.

Question 8

Explain KST (Know Sure Thing).

Answer 8

KST combines four different rate of change studies into one unified chart in order to analyze the long-term (primary) trend.

Question 9

Describe the “Nine-Month Cycle.”

Answer 9

An observation that commodity and stock prices follow a nine- to twelve-month cycle.

Question 10

What is a period?

Answer 10

The number of time units necessary to complete one wavelength or cycle.

Question 11

What is a phase?

Answer 11

A measure of the time location of a wave trough.

Question 12

What is the “Principle of Variation?”

Answer 12

The theory that cyclical patterns are strong tendencies and not immutable rules.

Question 13

What is synchronicity?

Answer 13

The principle that cycles of various lengths tend to bottom at similar times.

Question 14

Describe the relationship between cycles and market timing.

Answer 14

• Using historical market cycles to detect highs and lows offers insight into key turning
  points for a given market.
• Once identification of the timing of probable market reversals has been made, stock
  selection (for equity markets) becomes the key to profit maximization.

Question 15

Describe the structure of cycles.

Answer 15

• The extreme points of a cycle are known as peaks (tops) and troughs (bottoms).
• Other characteristics of a cycle are amplitude, period and phase.
• A cycle’s amplitude measures the height of the cycle, from the trough to the peak.
• A cycle’s period measures the length (i.e., the time) of one complete cycle, and is usually
  measured from trough to trough.
• A cycle’s phase defines the time location of a wave trough, and is used to measure the
  time difference between troughs of different cycles (phasing).

Question 16

Describe the cyclical principles of summation, synchronicity, and harmonicity.

Answer 16

• The summation principle states that all price movement is the sum of all active cycles. (THINK OF CONSTRUCTIVE AND DESTRUCTIVE INTERFERENCE FROM PHYSICS)
• The synchronicity principle states that cycles of varying lengths tend to establish
  troughs at similar points in time.
• The harmonicity principle states that adjacent cycles are often related by small whole
  numbers. (ex., 4.5 month, 9 month, 18 month)

Question 17

What are the various prominent cycles?

Answer 17

• The Kondratieff Cycle is a 50- to 60-year cycle of prosperity and recession in capitalist
  economies.
• The Jugular Cycle was proposed by Clement Jugular and is a 9 to 11year cycle of
  economic boom and busts.
• The Kitchin Cycle is a 40-month or 4-year cycle of economic activity.
• The Decennial Pattern is a repetitive 10-year cycle that begins with years ending in “1”
  (1971, 1981, etc.).
• Smith identified years ending in 2, 4, 5, and 8 as being bullish for equities, whereas
  years ending 1, 3, 6, 7, and 0 tend to be bearish.

Question 18

What are intermarket cycles?

Answer 18

Martin Pring has suggested that a relationship exists between stocks, bonds and
commodities based on the various stages of the business cycle.

Question 19

Explain the KST indicator.

Answer 19

• The KST indicator is a weighted average of four different ROC indicators (9-month,
  12-month, 18-month and 24-month).
• The weights are in proportion to the time covered, with the 24-month ROC having the
  greatest weight, thereby placing emphasis on the longer-term trend.
• KST is often filtered with a moving average, using crossovers to generate buy and sell signals.

Question 20

Explain how cycle analysis can be combined with other technical analysis tools.

Answer 20

Although cycle analysis identifies time windows for peaks and troughs, confirmation of a market turn should come from other technical tools and/or formations that occur
during these time windows.

Question 21

What is a cycle?

Answer 21

A series of events that are regularly repeated in the same order.

Question 22

How do the prices of most commodities reflect seasonal cycles?

Answer 22

The prices of most commodities reflect seasonal cycles, which means that these markets have a tendency to move in a given direction at specific times of the year.

Question 23

Provide an example of an ideal cycle peak.

Answer 23

If we have a 20-week cycle, for example, the IDEAL PEAK would be at the 10-week mark.

Question 24

Do peaks often fall at the ideal cycle peak?

Answer 24

NO! Cycle peaks often shift to either the left or the right of the ideal cycle midpoint. The trend of the next larger cycle helps to determine where a peak will occur. If the trend is bullish, then the cycle peak often takes place after the halfway point in the cycle and is said to be “translated to the right.” Conversely, if the longer-term trend is down, the cycle peak often shifts to the left of the theoretical midpoint and the cycle is said to have “translated to the left.” Why does this translation occur? In a bullish market, where prices are generally rising, optimism and confidence among investors tend to prevail. This positive sentiment can lead to a tendency for prices to continue rising for longer periods than anticipated. Conversely, in a bearish market, where prices are generally falling, pessimism and fear among investors dominate. This negative sentiment can lead to a quicker exhaustion of selling pressure, causing prices to bottom out sooner than expected.

UNDERLYING PRINCIPLE:

• In a bull market, upward price movements dominate and are more prolonged
• In a bear market, downward price movements dominate and are more prolonged

Question 25

When is harmonicity helpful?

Answer 25

This principle is helpful to find other cycles occurring for a particular security ONCE A RELIABLE CYCLE HAS BEEN IDENTIFIED.

Question 26

Describe an idealized Kondratieff cycle.

Answer 26

An idealized Kondratieff cycle depicting its various stages. The cycle begins with economic expansion at the trough that sees rising prices, a growing economy, and a strong bullish stock market. After a
few decades, inflation accelerates and the price of physical goods continues to rise as markets often
go sideways or even down during this time, leading to a recession. The “plateau” is characterized by disinflation or mild deflation followed by strong deflation as capital markets and the price of physical goods falls. A depression in business activity sets in, and debt liquidation takes place as the economy
resets itself for the next cycle.

Question 27

What is the difference between a durable and non-durable good?

Answer 27

Durable goods provide a stream of services or utility over time. In contrast, non-durable goods and services tend to be consumed immediately. In the case of consumers, examples of durable goods are motor vehicles and household furnishings; examples of non-durable goods and services include food and transport services.

Question 28

What is the business cycle and what are its phases?

Answer 28

The business cycle refers to the increases and decreases in economic activity caused by factors like interest rates, trade, production costs and investments. The four fundamental stages of the business cycle are expansion, peak, contraction and trough.

Question 29

Describe the interaction of bonds, stocks, and commodities during a typical business cycle.

Answer 29

Stage 1: Bonds rising (stocks and commodities falling)

Stage 2: Stocks rising (bonds rising, commodities falling)

Stage 3: Commodities rising (all three are rising)

Stage 4: Bonds fall (stocks and commodities rising)

Stage 5: Stocks turn down (bonds falling, commodities rising)

Stage 6: Commodities turn down (all three are falling)

Question 30

Why do bonds increase and decrease in value before stocks and commodities in the business cycle?

Answer 30

Bonds often react more quickly than stocks and commodities in response to changes in the economic cycle primarily due to their sensitivity to interest rates and inflation expectations, which are closely tied to economic conditions.

Question 31

What is a property of the lowest risk trades?

Answer 31

The lowest risk trades are in the direction of the trend.

Question 32

TRUE or FALSE: Cycles may only be visible on certain time frames.

Answer 32

TRUE! —-> Over shorter time frames, daily or weekly economic data can be quite volatile, with frequent ups and downs that may obscure underlying trends or cycles. Longer-term data, such as monthly, quarterly, or annual statistics, often smooth out these fluctuations, making underlying cycles more apparent.

Question 33

How can the KST indicator be used?

Answer 33

KST is often used in conjunction with a moving average. A crossover of the moving average above or below the KST study is generally a reliable indicator for timely entry and exit signals, while minimizing the amount of whipsaws.

• Entry Signal (Buy Signal):

When the Moving Average Crosses Above the KST: If the moving average of the price (commonly a simple or exponential moving average of a certain period) crosses above the KST line, it suggests that recent price action is gaining strength and momentum relative to the broader trend captured by the KST. This is considered a bullish signal, indicating a good time to enter or initiate a long position.

• Exit Signal (Sell Signal):

When the Moving Average Crosses Below the KST: Conversely, if the moving average crosses below the KST line, it suggests that recent price momentum is weakening relative to the longer-term momentum. This is considered a bearish signal, indicating a good time to exit or initiate a short position.

A whipsaw in trading refers to a condition where a signal is quickly followed by a reversal, often leading to a loss for the trader if acted upon. The use of a moving average with the KST can help minimize whipsaws due to the following reasons:

• Smoothing Effect of Moving Averages:

Moving averages naturally smooth out price data by averaging it over a specific period. This smoothing reduces the impact of random price spikes and short-term volatility, which are common causes of false signals and whipsaws.

• Combining Short-Term and Long-Term Indicators:

The KST, incorporating multiple time frames, reflects a broader perspective of momentum. When its signal is confirmed by the crossover of a moving average (typically reflecting a shorter time frame than those used in KST calculations), it helps ensure that both short-term price actions and longer-term momentum agree, enhancing the reliability of the signal.

• Delayed Signal for Confirmation:

While the use of moving averages might slightly delay the signal, this delay can act as a confirmation, ensuring that the trend is more established and thus reducing the likelihood of acting on a false trend reversal.

Question 34

What are the four phases of the Jugular effect?

Answer 34

Prosperity, crisis, liquidation, and recession.

After the recession phase, the economy gradually begins to stabilize and recover. This recovery leads back into the prosperity phase, starting the cycle anew. The transition is often aided by lower interest rates, easing of credit conditions, and restoring confidence among consumers and businesses.

Question 35

What are the four general categories of cycle lengths?

Answer 35

• long term (greater than two years)
• seasonal (one year)
• intermediate (9 to 26 weeks)
• trading (four weeks)