Introduction

Cycles are extremely important because they help us frame the market within the dimension of time. I was led to cycle studies by people whose work I respect, not the least of whom was Stan Harley (The Harley Market Letter; 805-484-4258), Timer Digest's 1998 Timer of the Year. Stan's work with cycles is not entirely unique, but he understands cycles as well as anyone I know, and he has been very helpful to me, both in my research to understand cycles better and in the preparation of this article.

I should also emphasize at the outset that this article represents my own interpretation of of what I have learned from others. The concepts are not altogether original, and I certainly give credit to those who have pioneered them; however, my conclusions may differ significantly from those of other cycle proponents. In other words, this is not necessarily the last or best word you will read on the subject.

The first thing we should do is ask what cycles are. This is not an easy question to answer, so let's just say that cycles are the observable tendency of prices to arc from trough (bottom) to trough at regular intervals. The price index will move upward from one trough until it reaches a crest (top), then the price index arcs downward into the next trough, or cycle low, as we sometimes refer to it. We can see the evenly spaced bottoms on the price chart that give evidence of the existence of cycles, but what causes this to happen? What is the cyclical force behind the price movement?

A stock market chart is a picture of human emotions expressed in the form of price movement. Fundamental events don't directly move stock prices, it is the emotional reaction to those events that moves prices. In a much broader context there are recurring events in nature and in the business cycle that affect human emotions. In other words, natural and fundamental events do affect the market, but only through the filter of human emotions. This is why it is so difficult to design economic or market forecasting models based on fundamentals -- humans can react quite differently to the same fundamental circumstances at different times.

The Foundation for the Study of Cycles has catalogued about 20,000 cycles. One of the most obvious and observable is the circadian cycle, the change from day to night to day, which is caused by the rotation of the planet (or the rising and setting of the sun, depending on your point of view), but, since it is only one of 20,000 cycles, it is obvious that cycle study is much more complex than we might like. We can observe recurring cycles in price movement, but we should remember that the "force" behind the cycle will manifest itself differently in each cycle, and, while we might expect a significant price low at a scheduled cycle bottom, it may not play out the way we originally forecast it.

Since a picture is worth a thousand words, let's look at an idealized illustration of Nominal Market Cycles below, a concept I am borrowing from my late friend and mentor Kennedy Gammage. Here we can see how cycles would look if they were perfect. There are two 10-Week Cycles within one 20-Week Cycle, two 20-Week Cycles within one 9-Month Cycle, and so on. Where cycles of different lengths make their lows at the same time, they are said to be "nesting".

The most compelling thing about this picture is the impression of power associated with major nesting points -- where all cycles are making lows at the same time at the 10-Week, 20-Week, 9-Month, 18-Month, and 4-Year Cycle lows. Visually we can sense that price declines into these major lows will be quite severe, while rallies off those lows will be explosive and powerful. Conversely, there other areas in the cycle structure where the cycle forces are mixed, with some cycles moving up while others are moving down, and it is hard to get a sense of exactly which direction a composite of these cycles would be pushing the market.

I have begun to think of cycles in terms of being a rising and falling of emotional energy caused by natural and fundamental conditions and events. While it cannot be quantified, we can imagine it as being something like the currents in a winding, fast moving river. Sometimes we can observe the currents on the surface, twisting and turning, combining with other currents and becoming stronger, splitting apart and becoming weaker, then submerging and disappearing completely, only to reappear again further down stream.

When applying this concept to price cycles, we can be a little more open-minded and cautious in our expectations of the cycles we are following. Sometimes we will be able to see the cycle quite clearly, and other times it will disappear. Sometimes it will behave in a predictable manner with the down side of the cycle resulting in price declines and the up side of the cycle resulting in price advances, while other times price movement will be quite different than we had anticipated. In other words, cycles are useful, but they are treacherous. Use them with care.

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