Time, the Natural Order of Things, and Cycles
Why time is the ordering principle, why change clusters at natural demarcations, and what cycles can and cannot carry.
Time, the natural order of things.
Over the years I have built a list of founding first truths. The kind that can be seen and understood by most people without a doubt. Rules that have clear, intuitive meaning. One of them is to expect change around natural demarcations and the larger the natural demarcation, the higher the impact will be.
Under the old paradigm that considered direction before context, if you are in a trend going up and near a projected target price look for a change of trend at the end of the month, quarter, mid-year or the New Year as these are natural times of change.
This is simply based on the opening and the closing of the accountant’s book and making adjustments for client reports or the changeover of managers, their hiring, and firing.
Under the new paradigm where context is considered first and direction secondarily, the reasoning is the same, except now we are looking at a model of background or environment, for Contrary Thinker's it is the Technical Event Model (TEM) as a leading sign of a change of context.
For example, if you are in early December on the weekly bar, trading a trend following system on the daily bar, and there is rule 2 or 4 on the weekly bar, expect that change to kick in the first few days of the New Year.
In mid-December 2015 TEM gave a leading rule4 suggesting a period of range expansion and moderating trend force. The change of trend kicked in the last day of the year and full on change the first week of the New Year.
Another example was the Rule2 on the mini Russell (TF) was reached in early June on the weekly bar but the actual change set in the first week of July in the new quarter in 2015.
Keep in mind the TEM is a two way street, it is dependent on the kind of strategy that is being filtered for use, it is not a trade signal, it is pointing out risk, when a period of profitability is coming to an end or when a period of profitability is about to being a particular system type, for example, trend following.
The first principle of cycles effects on conditions.
Technical analysis of the market is successful because the market is not always efficient. Discernible events that occur in chart patterns, such as double tops and Elliott waves, enable trading to be guided by technical analysis. Cycles are one of these discernible events that occur and are identifiable by direct measurement. Identification of cycles does not take a lifetime of experience or an expert system. Cycles can be measured directly, either by a simple system such as measuring the distance between successive lows
The fact that cycles exist does not imply that they exist all the time. Cycles come and go. External events sometimes dominate and obscure existing cycles. Experience shows that cycles useful for trading are present only about 15 to 30 percent of the time. This corresponds remarkably with J.M. Hurst’s statement that “23% of all price motion is oscillatory in nature and semi-predictable.” It is analogous to the problem of the trend follower who finds that the markets “trend” only a small percentage of the time.
Arguments that cycles exist in the market arise not only from fundamental considerations or direct measurement but also on philosophical grounds related to physical phenomena. The natural response to any physical disturbance is harmonic motion. If you pluck a guitar string, the string vibrates with cycles you can hear. By analogy, we have every right to expect that the market will respond to disturbances with cyclic motion. This expectation is reinforced with random walk theory that suggests there are times the market prices can be described by the diffusion equation and other times when the market prices can be described by the telegrapher’s equations
The challenge for technical traders is to recognize when the short term cycles are present and to trade them in a logical and consistent manner so these cycles can contribute profitably to the bottom line.
Where this breaks down
- [Draft , Jack to add failure modes and conditions under which this framework breaks down]
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