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Wave Cycles and a Day Full of News

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Published : October 09th, 2011
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Gerald Loeb, in his classic tome “The Battle for investment Survival”, wrote that an investor must be proficient in fundamental analysis and must have working knowledge of technical analysis but in the end it is the man that can walk outside, breathe the air and know which way the wind is blowing that will be successful.

I must admit that I never put much credence into these wave and cycle theories but I think that it is important in this world of high frequency, algorithmic trading that it is important that I understand these theories but also do my bests to help my readers understand them as well.

Today I wanted to write about different wave analysis theories that are becoming more and more a part of the markets algorithmic trading that accounts for about 80% of the trading that takes place. The wave principal incorporates cyclical and secular movements in financial markets in an effort to capture the overall psychology of the investors. Cycle analysis has played a significant role for investors in determining the future direction of financial assets over the past century.

Riskier assets such as commodities have shown cyclical tendencies over the decades and there have been a number of studies that have explained the historical wave patterns of commodities such as the Elliot Wave Principal, the Kondratieff cycle and the Longwave Principle.

Wave analysis, as it relates to the markets is simply the study of supply and demand of a stock based on a specific criterion. The Elliot Wave Principle focuses on price action, where the Kondratieff and Longwave theories combine specific data points.

The most coveted to these cycles is the Elliot Wave Principle which is a form of analysis that traders use to analyze market cycles. He underlying theme in the Elliot Wave is to identify investor psychology and attempt to create a technique to measure this psychology and how investors react to events.

Ralph Nelson Elliot developed the principles of the Elliot Wave during the 1930’s and published his theory of market behavior in a book “The Wave Principle” min 1938.The theory analyzes specific price movements or waves which determine a point in a cyclical trend. An example of his theory is that long term bull markets move up in five waves while long term bear markets move down in three waves. During the upward bull market movement each wave is accompanied by corrections (labeled A, B and C) which are downward cycle waves.

There are three basic rules for the Elliott Wave principle:

1. Wave 2 cannot retrace more than 100% of wave 1.

2. Wave 3 can never be the shortest of the three impulse waves.

3. Wave 4 can never overlap wave 1.

The second theory is called the Kondratieff Cycle. The Kondratieff Cycle is a theory based on a study of price behavior combined with economic data which includes wages, interest rates, raw material prices and other factors that affect economies. Kondratieff was convinced that his study of economic, social and cultural life proved that economic cycles existed and could be used for the purpose of anticipating future economic developments. The wave theory is centered on a growth and a contraction phase of the long wave, when growth and deflation are at their peaks respectively. The analysis differs in that it is less technically oriented and analysis specific economic data points to determine levels of waves.

The Longwave principle is based on the belief the Kondratieff Cycle repeats itself over time. While the Kondratieff Cycle applies to past events, The Longwave Cycle looks at many factors to determine where we are presently and uses that information to forecast the future price action and economic activity. The Longwave Principle looks at the life cycle of an economy and uses those points to project the psychology of market investors.

The concept of a commodity super cycle grabbed the attention of the investment community after the Federal Reserve announced QE2 during the summer of 2010. With the economy reeling, many thought that a shot of liquidity would drive inflation higher and eventually create growth and higher inflation. The question for most analysts is whether commodity prices could climb two or three fold despite moving higher by 70 percent since the lows reached in March of 2009.

One analysis that can be used to forecast a super cycle in commodities is to examine the long term price trends and apply the Elliott Wave Principle. The pattern for price expansion or growth is depicted as a five price swing sequence from mid 2002 to late 2008. Five waves were completed and reversed during the financial crisis of 2008 – 1009 which quickly ended the cycle with a crash of commodity prices. Please see chart below.

I chose this chart of the Reuters / Jefferies CRB Index because over the years from 2002 to 2009 it is a perfect proxy chart that illustrates the Elliott Wave. It illustrates the 5 waves perfectly.

Markets have rebounded and there are some factors that could take commodity prices above the recent 2008 highs.

I will finish my thoughts on the wave cycles in another post but before I take my leave I wanted to spend a bit of time talking about the news coming out today.

U.S. equities are expected to stay steady on Friday after sharp gains in the previous session, with futures for the S&P 500 staying flat, for the Dow Jones gaining 0.08 percent and for the Nasdaq 100 falling 0.07 percent.

At 8:30 EST the Labor Department will release the employment report. Economists forecast that a total of 60,000 jobs were created in September compared with no new jobs in August. The unemployment rate is seen at 9.1 percent, a repeat of the August rate.

The Commerce Department will release wholesale inventories for August. Economists predict inventories to rise 0.5 percent versus a 0.8 percent increase in July.

The Economic Cycle Research Institute releases its weekly index of economic activity for Oct. 1. In the prior week the index read 121.9.

The Federal Reserve will issue August consumer credit. Economists in a Reuter’s survey forecast consumer credit to raise $7.75 billion versus an $11.97 billion increase in July.

The U.S. House of Representatives and the Senate will vote next Wednesday on three long-delayed trade deals with
South Korea, Panama and Colombia.

The Bank of
Japan kept monetary policy unchanged on Friday, holding off from tapping its depleted policy arsenal for now although fears of a global recession and Europe's debt crisis are clouding the outlook for the fragile economy.

Credit agency Moody's cut its ratings on British banks Lloyds and Royal Bank of Scotland on Friday and said it expected the UK government would have to continue to support the country's systemically important financial institutions.

Today the FTS Eurofirst 300 index of top European shares rose 0.7 percent after the European Central Bank's offer on Thursday to help struggling banks. Japan's
Nikkei average rose 1 percent.

In conclusion, there will be a lot of news to digest today and it all has the potential to move the market.
It promises to be a very interesting day.



Data and Statistics for these countries : Colombia | Panama | South Korea | All
Gold and Silver Prices for these countries : Colombia | Panama | South Korea | All
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George Maniere has an MBA in Finance and 38+ years of market experience, and has learned by experience that hubris equals failure and that the market can remain illogical longer than you can remain solvent. Please post all comments and questions, and feel free to email him at He will respond.
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