Novice Traders' Notebook  |  SEP 1997

Do Cycles Exist in the Market? by John F. Ehlers

This longtime S&C contributor explains the basis of the existence of cycles in market data. The markets are not always efficient; this is why trading decisions based on technical analysis work. Chart patterns that are discernible, technical events such as double bottomsÝ and Elliott wavesÝ, allow technically based traders to make intelligent deci-sions. Another key discernible event that technical traders may make use of comes in the form of cycles. As a rule, it is not a task of much difficulty to identify cycles; a simple ap-proach, such as measuring the distance between successive lows, can be used to measure them, or a more sophisticated approach using computer algorithms such as maximum entropy spectral analysis (MESA) can be used. However, the observation that cycles exist is not to imply that they exist at all times. Markets can be caught off-guard by events that can and have on occasion dominated and obscured present cycles. Research indicates that cycles use-ful for trading are present only about 15% to 30% of the time, corresponding with technician J.M. Hurst’s comment that “23% of all price motion is oscillatory in nature and semi-predictable.” The situation is comparable and indeed parallel to the problem that the trend-follower faces when he or she finds that the markets trend only a small percentage of the time.

by John F. Ehlers