Wednesday, March 15, 2017

Using Cycles to Trade Market Trends

Even in trending markets, we see cyclical behavior.  In a distinct uptrend, we will make cycle lows at successively higher price levels.  In a downtrend, we make cycle highs at successively lower price levels.  Those cyclical movements can provide worthwhile entry areas for those looking to ride longer-term trends.  In other words, we can participate in a trending market by going with the trend for our trade but entering countertrend with the market cycles.  This is different from momentum trading, where we're looking to buy strength and sell weakness on price breakouts.  In a low volatility environment, using momentum to time entries can lead to getting chopped up.  

The chart above depicts cyclical behavior in SPY (blue line) as a function of a moving average of the percentages of stocks in the index trading above various moving averages (data from Index Indicators).  You can see we're in oversold territory on the measure at a higher price low.  This leads me to expect at least a retest of recent highs in the market's bigger picture.  Very good short-term trades can be found when intraday flows line up with this larger market picture.

This is yet another way that we can integrate quantitative and discretionary information in our trading.

Further Reading:   Trading Market Cycles