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Module #2 – An Introduction To Cycle Theory -

You have almost certainly heard of the “boom and bust” cycle that drives the economy generally. Things go well for a while, and then the good times are interrupted at periodic intervals by recessions.

Few people would argue that this cycle does not exist, and fewer still would argue that it doesn’t have a profound effect on the market but defining it with any precision is fraught with difficulty, not the least of which is because different markets react with different lags and with different sensitivities to the economic cycle.

Then there’s the fact that some markets are impacted more heavily by exogenous events than others. For instance, livestock and agricultural commodity prices are unquestionably impacted by weather patterns (cycles), while the stock price of, say, a bank is generally impervious to such things.

On the other hand, financial markets are affected by cyclical events like dividend payouts, Treasury funding programs, the release of governmental statistics on a periodic basis, company reporting seasons, and the like.

Another problem with Cycle Analysis is the fact that there are other trends and influencing factors at play simultaneously, and the cyclical element itself may or may not be the dominating factor at any point in time.

All of that combines to make the study of Cycle Theory a tricky proposition, which makes it only natural that Cycle Theory would have its share of skeptics and naysayers.

In the book, “Schwager on Futures – Technical Analysis,” authors Jack Schwager and Richard Mogey sum it up like this:

“ There are probably not as many cycles as cycle enthusiasts say there are, and certainly not as few as the opponents of Cycle Research claim.”

On the face of it, charting technical data for markets involves plotting price over time. A great deal of emphasis is generally placed on precisely how to analyze price, but relatively little emphasis has been placed on time.

You can see this most clearly when you look at point and figure charting, where time has almost no impact.

Even in trend analysis, time’s impact is minimized – after all, it’s obvious that a trend chart has a time reference, but price is the primary data point people are looking at. The specific timeframe is still secondary.

This begins to change when we start looking at trend following and momentum indicators, where time has a more important influence, taking the form of the choice of time periods over which the indicators are constructed.

In a topic later in this course (Gann Analysis), we’ll be taking a much closer and more serious look at time. Gann’s work was carried out in the first half of the century, and while other analysts had looked at time cycles very broadly, Gann is credited as being among the first to examine time and time cycles as applied to market analysis.

For now, in this part of the course, we’re going to look specifically at the work of Cycle Analysts who posit that time cycles are the real key to why markets fluctuate. These analysts see cycles as a means of forecasting not just the direction of prices, but the time period for which any given trend will run.

Further, given that they see cycles as the underlying key that defines market fluctuation, it is their belief that all other forms of analysis can benefit from and be improved by the incorporation of Cycle Analysis. One example of this takes the form of optimizing moving averages and oscillators, based on cycle lengths.

One of the main difficulties in teaching the art and science of Cycle Analysis is the fact that it involves much more than merely looking at a chart and noting regularly occurring highs and lows, then concluding that there are cycles at play and attempting to use them for forecasting. The problems is much more difficult and subtle than this, and involves careful validation of cycles. After all, the human eye attempts to spot patterns everywhere it looks, even in data sets where no pattern is readily apparent.

This is the reason that Cycle Analysis requires highly specialized software, so again, we won’t be delving too deeply into the notion of teaching you HOW to perform such analysis. Our primary objective here is to give you a general overview of the study of cycles and to make you aware of the challenges and difficulties, but also of the benefits of mastering Cycle Analysis.