It’s been a while since I posted anything to this site – and the reason is not sheer laziness. It is because I had what might be called an epiphany a little over a month ago – one of those “bright lights in the sky” kind of moments, and that’s what I want to write about here – what I’ve called the “hidden secret” of cyclic theory. The other reason it’s been such a long time since my last post is that I’m currently directing So You Think You Can Dance and Strictly Come Dancing (the South African versions) … and those shows take up a lot of time!
So what is this “hidden secret”? Cyclic theory (at least the aspect of cyclic theory that Thinking Trading Software uses, as defined initially by JM Hurst) is based on the idea that stock market price movements are the result of the complex combinations of many different cycles. They differ in amplitude (in other words how much price movement they cause), and also in period (how long between each cycle trough – also called wavelength, or the inverse of frequency). I have mentioned elsewhere on this site that one of the differences between JM Hurst’s theories (and the theory TTS uses) and many modern day practitioners of cyclic theory is that Hurst constantly emphasised the fact that many cycles combine to produce a composite price movement, whereas the modern team generally talk about cycles in isolation from one another – there is much talk of “identifying the dominant cycle”, and then trading on the basis of that cycle only. That’s all very well, but the hidden secret I believe I’ve stumbled upon is all about the ways in which the many cycles combine, and illuminates the reason why tracing only a single cycle can be so disastrous to one’s trading account balance.
A sine-wave cycle
Let me start at the beginning, and try to explain. The basic cycle (of which Hurst says there are many, in fact an unlimited, infinite number), looks like your standard sine wave. Above this paragraph (if I’ve got the formatting of this page correct) is a graph showing two complete cycles of such a sine wave. Let’s assume that this wave is a depiction of the 54-month (4 & 1/2 year) cycle, believed by Hurst to be present in the movement of stock market price movement. That means that something (call it “social mood” or “the X factor”) is causing prices to rise and then fall as depicted in this graph – one complete cycle (up then down) in 4 and a half years. That’s all very well – but this doesn’t look much like a graph of a stock market price, and that’s because a stock market price is moved by a combination of many cycles! So let’s start combining them!
Two sine waves combined
Now in this graph (should be above this) I have combined two sine-wave cycles, using Hurst’s Principles of Harmonicity, Synchronicity and Proportionality. What this means is that the waves have periods that are a small integer multiple of each other (in this case 2 – the pink wave has a period that is 2 x the period of the blue wave), and the troughs of the waves, where possible, occur at the same time (synchronicity), and the amplitudes of the waves are proportional to their periods (the pink wave is 2 times the amplitude of the blue wave). The white line is the combination of both these sine waves (using the Principle of Summation, which basically states that you add them up!) Now the point I’m getting to is that a trough in the blue wave (the same 54-month wave depicted above) appears differently to another trough of the same wave, depending on the influence of any longer cycles. So imagine that you were trading this 54 month cycle – you would want to buy at the trough of the cycle, and sell at the peak. If all you did was consider the 54 month cycle, you would have made a very disappointing trade at point A in the graph to the left. Although you have correctly identified that point as being a trough of your trading cycle (the 54-month cycle), the price move up from the trough (as shown by the white line) is very disappointing – it is completely different in scale to the price move up from the trough positioned at the extreme left of the graph. So the point I’m making is that one cannot trade cycles in isolation – one has to consider the cycle in the context of all cycles longer than it.
Combined cycles from 54 months to 18 years
OK, so I’ve demonstrated that by simply considering the cycle one up (the cycle with the next longest wavelength) from your trading cycle you can avoid some disappointing trades. What happens if you consider more than that? Take a look at the graph above. The blue cycle in this graph represents the nominal 18-year cycle – which is the cycle two up from the 54-month cycle (the 9-year cycle is the only cycle between them). Now look at the white line that is once again the summation of all the cycles considered (in this case every cycle from 20-weeks up to 18-years). I have marked the 54-month troughs with the red arrows A, B & C. Now that we are considering two longer cycles, the effect of the 54-month troughs on the composite price movement (in other words the price movement created by combining all the cycles) are very different. If you’d bought at point A, a 54-month trough, you would have made a pretty profit. Same thing at point B, just with a slightly differently shaped curve on the upward path. Then, emboldened by two successful trades of the 54-month cycle, if you had bought at point C, which is a genuine 54-month trough just like points A & B, you would have been in for a nasty surprise … the price bumps up for a moment (apparently confirming your decision to buy) … but then it plummets. There is of course another 54-month trough that I haven’t labelled, at the extreme left of the chart. Buying at that point would have positively made you think you were a trading genius because of the way the price rocketed up for about 6 years!
Unfortunately the situation is even more complicated than combining two cycles as described above. Hurst mentions in his work that the longest known cycle is probably 18 years (and that was back in the 1970’s), and one might ask why one should need to know about cycles any longer than that … well this is the hidden secret I’ve been trying to get to: I believe one does need to know about the longer cycles, all of them (even if they are all lumped into one imperfect and slow movement – what Hurst calls Sigma L) because, as I hope I’ve demonstrated, the longer cycles have a great impact on the effectiveness of the shorter cycle troughs as buying points.
Combined cycles from 54 months to 54 years
And so one final chart. In this chart I have combined all cycles from 54-months up to 54-years. I believe there are two alternatives for the cycle one up from the 18 year cycle – a 36-year cycle, or a 54-year cycle. The 36-year cycle has a wavelength 2x as long as the 18-year cycle, and the 54-year cycle has a wavelegth 3x as long. I prefer the idea that the 54 year cycle is in fact the next wave up, because of the symmetry with Hurst’s 18-month to 54-month cycles, and also because 54 years is generally considered to be the length of the Kondratieff cycle. But without actual evidence, I’m unwilling to commit to either, and in any case we need not only consider the 36/54 year cycle, but also all cycles longer than them, so the Sigma L “cycle” will by no means be a perfect sine-wave cycle itself. What I have done in the chart to the left is demonstrated both the 36-year cycle (the blue line, composite price is the pink line), and the 54-year cycle (the green line, composite price is the white line).
I have again labelled all the troughs of the 54-month cycle with red arrows, labelled from A to K, and of course there is another trough at the extreme left (or right, because they are the same trough) of the chart. Take a look at each of those arrows, and I think you will agree that trading the 54 month cycle is not merely a matter of buying every 54-month trough. One has to know what is happening to all the other cycles, in order to know whether a particular 54-month trough is likely to result in an impressive price rise. Consider for example point K – that is a 54-month trough, but I certainly wouldn’t want to buy there (irregardless of whether the longer cycle is 54 years or 36 years).
So here is the “hidden secret” to cyclic theory:
One can only trade profitably using cyclic theory if one is able to identify all of the cycles impacting upon a particular stock’s price movement at any one time. It is a mistake to say that because price is at the trough of any particular cycle, it will necessarily rise to a degree commensurate with the wavelength of that cycle – the impact of a particular cycle is governed by the status of cycles longer than it (what Hurst calls the underlying trend of a cycle).
Choosing one cycle (as the dominant cycle) is therefore no good as a trading strategy. It was this “epiphany” that has had me working hard at having Thinking Trading Software take this idea into account, and be able to identify the shape of the Sigma L (or sum of all longer cycles) “cycle”. I am getting there … slowly. My earlier posts to this site with analyses are, I believe all still valid, but they have a critical missing factor – which is what I guess I could call the Sigma L, or underlying trend factor. Over the near future I’m going to be revisiting all the commentaries and analyses I’ve made using TTS, and re-evaluating them in the light of the software’s new “Sigma L” functionality. I expect that the phasing analyses will not change much, but what will change is the expectation of future price movement. And that after all is what my quest is all about – predicting the direction of future price movement.
I’ve been trading for over 15 years, and I’ve traded many things, including shares in South Africa, shares in the US market, futures on the S&P500 and Nasdaq, currencies, single stock futures, and so on. Trading fascinates me.
The Potential of Trading
Trading offers the potential, if one knows what one is doing of providing a perpetual source of income. I say “if one knows what one is doing”, because I have learnt the lesson of “not knowing” the hard way (one day I’ll tell the story of how I lost $5,000 in a single day). And after spending a good deal of the last 15 years studying everything I could find about how to trade “knowingly”, I do believe that I’ve found a way of doing it. This “way of doing it” is what I call “The Trading Theory”.
The Trading Theory
This is a trading theory inspired by the original work of JM Hurst, who studied cycles in the stock market (in the late 1960’s and 1970’s). I have added to the theory some extra details, and I believe the theory works (in other words one can make money by trading it) … I have spent a lot of time studying it, looking at it from every angle, and I still believe it works! So what’s the catch? The catch is that this is not a simple theory. It’s not a get-rich-quick theory. It is complicated, and involves several “barriers to entry”:
So in order to do all these things, and really put the theory to the test, I am creating the software which this blog is all about. To really do the trading theory justice one needs something to help one overcome the barriers I’ve described above, and I think software is just the right thing.
The Problem with Trading
I have many friends who “trade”, in which description I include those who buy stocks and shares for longer term invetsment. Trading is pretty easy to get into – open an account somewhere, pick a share/currency and then buy it! All too often I believe people get into trading (or longer term investing) without knowing what they are doing, and often do really well for a while (sometimes even years). But then just when they think they know it all, they start losing money, and before they do know it all they’ve lost everything they made in the first place, plus a bit more.
Why does this happen time and again? Because people who trade (or invest) in this way don’t actually know what they’re doing. I know that’s harsh, but most of the time it’s true. There is a well-known saying in the trading world: “don’t mistake a bull market for your own genius”. If you buy shares in a bull market (which is a rising market) they are pretty much bound to go up. If you then make the mistake of thinking that it was your genius that guided the choice of share, or the time at which you bought the share, then when the market turns into an angry bear (as is happening pretty much worldwide at the moment) and starts falling, you’re going to suddenly realise how little you actually do know.
My favourite question to friends and people I meet who also trade is: “what guides your buying and selling decisions?” Would you believe me if I said that most people don’t really have a “theory” they work with? They listen to other people’s opinions on the radio and TV, and vaguely make a decision based on their “gut feel” about a share. Sure, some of the time they’re right, but let’s face it: some of the time they’re not! That’s all very well if it’s a hobby that amuses you, but if it’s your plan for the future, I think that is pretty disastrous. The way many people talk about trading reminds me frighteningly of the way gamblers speak about their gambling exploits: A gambler will phone their friends in great excitement on the occasion of a big win (a big party for all the friends, everyone talking about how the gambler has a “lucky gene”). But what happens when they lose money? Do they phone all those friends? Not likely, unless they need a loan, and so one tends only to hear about all the wins, and none of the losses. All too often I find that happens with traders I have met – great stories about making thousands of dollars in a few days, but not so many stories about the losers. The problem is I think those people are doing little more than gambling with their money. For their sake I really hope their lucky streaks hold good as the world markets twist and turn.
Most of them answer any concerns I express with the stock response of – “in the long run stock markets go up, even if it means you have to wait a little longer”. I must say I think that idea has run its course – there is no rule anywhere saying that stock markets cannot start going down, and keep going down. And even if a market always has to turn back up again, what if it only happens in 80 years time? Might be a little late to enjoy the upturn! I’m a keen reader of Robert Prechter’s The Elliott Wave Theorist in which he often discusses spurious ideas such as the belief that stock markets must inevitably go up. If you’re interested in trading well, I highly recommend his newsletter – you might not agree with all his ideas, but it’s always good to question one’s own beliefs now and then.
The Challenge
And so for me the challenge is to trade in a way that can be genuinely defined as “knowing what you’re doing”. Obviously everyone has their own idea about what that means – and this project is my own personal quest to find the solution to that question. Perhaps I should say “to express the solution”, because I believe I have found it already, I just need to find a way of expressing it so that others can use it and benefit from it. I would love for all my friends, acquaintances, and many others to use my software to make themselves wealthy, because that is what it’s all about – sharing the knowledge of how to trade.
It would be so much better than hearing that friends have bought shares in a stock that I’m convinced is going down … but tact prevents me from saying anything. I think the time for tact has passed.
My background
I came to trading in an unusual way, which might inform my readers a little! I knew the stock market existed, but it never held any interest for me because it all sounded like serious business, and my only awareness of it was when the closing prices of many shares were announced on the radio in South Africa. It all sounded so boring. I admired the way the radio DJ’s would vary their tone of voice as they announced each share price so that it didn’t sound too monotonous, but inevitably my mother would change the station to something musical, and that would be it.
But then I developed a strong interest in gambling games – roulette, blackjack and the horses. I know one’s not meant to mention gambling and stock market trading in the same breath but I’ve done it twice (or three times) now in one blog, and the reason is that I believe the two do have many connections. What fascinated me about the gambling games was the mathematical side of things – the concept of probability and the statistics of chance. A wonderful book called Thirteen Against the Bank by Norman Leigh inspired me to team up with a friend and “beat the bank” but that’s another story for another time (the system doesn’t actually work mathematically – I guess Norman and his team were lucky). When researching a theory I had about the potential of making money out of statistically based bets placed on the Horse Racing pools (again another story altogether…), I came across the concept of time series, and ended up reading a book about the technical analysis of stock market prices. I was immediately hooked, and have spent the last 15 years reading pretty much everything I can on the subject. My particular interests are technical analysis (perhaps that’s obvious!), but more particularly the fields of Elliott Wave analysis, and Cyclic Analysis (with emphasis on the work of JM Hurst, and those who have followed him).
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