Wednesday, March 12, 2014

Cycle model update

Further to yesterday's post about the 20-week cycle (Cycles in the eye of the beholder), where my former Merrill Lynch colleague Walter Murphy identified this week as the bottom of the 20-week cycle (which lasts 21-22 weeks), a reader noted that the chart that I showed spanned five years, which represented a bull market. As such the "buy" signals represented by the 20-week cycle was tested on a market that had an upward bias.

Here is the same chart of a 21-week cycle for the last 10 years. The vertical lines represent supposed 21-week cycle bottoms. The blue arrows represent "good" buy signals, where the market was higher 4-6 weeks later; and the "red" arrows represent "bad" buy signals, where the market fell 4-6 weeks later.

Here is the good news. There are still more blue arrows than red arrows despite the devastating 2007-2009 bear market. What's more, this was able to identify short-term bottoms in the waterfall decline of 2008 and therefore these results make the 20-week signal intriguing as a timing tool.

The bad news is that this identified the 2007 top as a bottom and missed the ultimate bottom in 2009 all together.

Does this make the 20-week cycle a useful market timing tool? I have always been somewhat skeptical of the cycle approach to technical analysis, but this chart has changed my mind. My preliminary conclusion is that it may be useful and deserves a place in the toolkit of a technical analyst.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). The opinions and any recommendations expressed in the blog are those of the author and do not reflect the opinions and recommendations of Qwest. Qwest reviews Mr. Hui’s blog to ensure it is connected with Mr. Hui’s obligation to deal fairly, honestly and in good faith with the blog’s readers.”

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1 comment:

Anonymous said...

If you want to know whether it is meaningful or not, you have to compare it to similar alternatives. Look at 10, 15, 25, and 30 week cycles. You can also offset where the cycles start. You will probably get the same results. Or calculate what percentage of weeks would have been a good buy using your metric (higher 4 weeks later). The decline was rapid, so only a small number of weeks would not qualify as good. Your chart has a hit rate of 17/24, or 71%. I don't actually think that is very high for a 4-6 week holding period, particularly since you aren't accounting for the magnitude of the price moves.