by Rick Ratchford
When it comes to analyzing the Futures, Commodity and Forex markets, as well as the Stock markets, you have two choices for cycle analysis: Fixed Cycles and Dynamic Cycles.
Much of the talk about cycles in futures trading has dealt with commodity markets such as livestock, softs and grains. These are excellent commodity markets to explain futures and commodity cycles because they are natural products. They either grow from the ground and rely on the seasons and weather, or they are raised from the ground (rely on foodstuffs) as well as have seasonal tendencies such as periods of raising and periods of harvest (slaughter).
Fixed Cycles: Some futures and commodity markets, at least for a period, will follow a fixed cycle. Every x-number of days you are to expect a cycle turn in trend. Whether it is every 28-or12 days, whatever. Once you discover the market cycle interval, you then count from one major top or bottom that number of days to see if another top or bottom forms.
The problem with fixed cycles however is twofold. 1. They tend to disappear all of a sudden without any warning, only to reappear at some unknown date in the future. Could be months or years? 2. Markets are not static, but rather they are dynamic. Ebb and flow, expanding and contracting. If they were fixed, we'd all have a nice map of when to expect turns, and there would soon be no market. Must change to keep you guessing?
Dynamic Cycles: Dynamic market cycles are much more difficult to unveil, but well worth it. Since futures, commodity and forex markets are dynamic, you will end with a top or bottom occurring at different time distances, rather than every x-number of days. It is easy for those familiar with radio waves to grasp this, but I will try to explain its development.
Consider for example the effect the moon has on ocean tides. It does not move up and down at equally spaced intervals, but rather they occur at different spacing. Thus, a mathematical model had to be developed based on where the moon and sun is at anytime to determine tides. Do a search on Tides in Alta Vista search. There is a website that will provide you the tide times for different bodies of water in the US. You should immediately note the differences of time and amplitude of each of these tide charts.
The influence of the moon depends on its location relative to any given longitude/latitude on a map. That is why at the same time each day, each place has a different cycle pattern. The futures, commodity and forex markets move like these cycle patterns. They are not fixed, but dynamic. Those patterns are not the result of one thing . . . i.e., the moon. They are the result of the moon, sun, and other parameters. That is why it is not fixed. The influence of different Signals, if I may use that phase, distorts a purely fixed cycle, like a sinwave for example. This distortion is what you see in the markets.
If you take the cycle pattern for a given time, for a given market (see how complicated it gets?), and were to detrend or extract the individual cycles from the complete pattern, you'll see each component is a Fixed cycle. It's the blending of all these fixed cycles that distort into one that is dynamic.
One other thing. The stronger fixed cycle component in a dynamic cycle has its way. If one strong fixed cycle has to go against several weaker fixed cycle components going the other way, the combination (simple addition/ subtraction) will provide a wave that is the result of the difference.
For example: Let's assume that a particular futures, commodity or forex market is influenced by certain external forces. Say there are four external pulls on the market (in reality, it is more a pull on the traders themselves, a whole other lesson). Say you have:
1. A (amplitude of 10) 28-day fixed cycle.
2. A (amplitude of 3) 12-day fixed cycle.
3. A (amplitude of 5) 5-day fixed cycle.
4. A (amplitude of 2) 14-day fixed cycle.
Now, if you have 4 fixed cycles like the one above, they obviously will be going the same direction sometimes, going in opposite directions at other times, and a portion thereof at other times still. Take a piece of paper such as a graph paper, and have all 4 start on the same vertical line. Using the amplitude values provided (start from the center line to have room upside and upside down), draw each as a nice even sinwave (looks like smooth camel mounds, upside and upside down).
If you take the power of each one (amplitude), and add them all up, you get the resulting wave for that time frame. The starting location is called level 0, so when it goes above it is positive amplitude, and when it goes lower it is negative amplitude.
So, starting from the center of the page, draw the first sinwave cycle with the amplitude of 10. That means 10 horizontal lines up from 0. Draw a smooth camel hump that will top 7 vertical lines from where you started, and drop back to 0 7 bars after that. Now draw it another 7 lines forward, this time below the 0 line making an upside down camel hump (or bowl) and then back up to 0 again. This also should be 10 horizontal lines down. This is one complete 28 fixed line cycle with an amplitude of 10. You should note that if you were to connect the open end that began this cycle, to the final open end, you would have a complete circle, or a 360 degrees. A end returning to the beginning to once again start over.
From the same starting point, do this with the other 3 fixed cycles above, but note each individual amplitude (horizontal above and below the 0 line) and the vertical forward lines (from 0 to top to 0 to bottom to 0). You simply take the cycle duration and divide by 4 to get the vertical moves. 28 cycle was 7 up, 7 to 0, 7 down, 7 to 0. Once complete cycle is 28. This is a true cycle. When a trader is referring to a 28-day cycle, he is usually going from bottom to bottom or top to top. That is half a cycle, but this is getting deep.
If you plotted your cycles smoothly and evenly, you will be able to do the next task. Take another graph sheet of paper. Staring at 0, you will start to draw the results of combining all these 4 fixed cycles together. Each line above zero is 1 amplitude value. Each line below is -1 amplitude value.
Now, vertical line to vertical line on the original paper is to align with your new sheet in terms of time. First vertical line, note the amplitude of each of the 4 cycles. If you started each one going up, they will all add to each other to end with a positive number. If they all were drawn starting downwards, they would all add up to be a negative number. If some went up and some down, they all add up, thus the result will be the difference between the up and down waves.
Let's assume you went up on all of them. Add up the total and plot it on your new sheet. From zero, move right one line and up one line to the proper amplitude. Do this for each line up and to the right if the number is positive, and line down and to the right if the number is negative. Each line to the right deals with Time, and the horizontal lines deal with amplitude. 0 to 10 up, 0 to 10 down. That is because our biggest wave is an amplitude of 10.
So, if 4 lines to the right we are sitting on an amplitude of say 6, and we note that on line 5 to the right of the original chart we have (+6, +2, -1, -3) for example, the result would be to move our line down to amplitude 4, as this is the result of adding the 4 amplitude values. So you would draw your line from 6 to 4 when going from vertical line 4 to 5. This was just an example. Once you are done from left to right, you now have a dynamic cycle which is the result of combining 4 fixed cycles. Those knowledgeable of radio waves or dynamic cycles are aware of this.
I hope this enlightens you to the differences of fixed and dynamic cycles. The type of cycles I deal with are dynamic. This is because the Futures, Commodity and Forex markets are also dynamic. You can achieve better precision in market forecasting by understanding the dynamics behind the patterns you see on your Futures, Commodity and Forex market price charts.