Why understanding market cycles is key to smart trading

In session Understanding market cycles is key to successful trading in stock. FILE PHOTO | NMG   

By RUFUS MWANYASI

More by this Author

Summary

• Markets can remain bearish for as long as they “desire”. However, keen trend watchers can always spot the signs when the “cycle-down” has petered out.
• Whether scientists think this is an illusion or not, “pattern recognition” is critical to investors’ ability to learn from past experiences and anticipate challenges as well as threats in the markets.

people see images in the sky or hear certain voices in random sounds? Why do people see patterns where in fact none exists or make sense in meaningless noise?

Well, though scientists are yet to find a common answer explaining the why, at least they have a word for this phenomenon, patternicity.

And one place where men have found order within chaos or at least have sought and found patterns, is in the markets. One will often hear about business and economic cycles, cyclical stocks, seasonal businesses, boom and bust cycles, return-to-equilibrium and so on.

Yet, the underlying question is fundamental – are market cycles important to investment success? I firmly believe so.

But before I jump onto the subject matter, allow me to share a personal story. A couple of years ago when I began researching on market cycles, I came to the conclusion (after four years of work) that markets are undeniably repetitive by nature.

The lesson that market “noise” (stocks, debt, currencies, commodities etc) followed a non-linear path that was cyclical was quite profound to me. From that point, I have gone to build my own investment style upon this truth.

Many days after this experience, I’ve found the work by the renowned meteorologist, Edward Lorenz (father of chaos theory) quiet inspiring.
Now, back to the story, here are three reasons why I believe cycles are important.

One, there are those who keep calling a bottom simply because the current market is trading at a P/E ratio of 10x or that the shilling must strengthen because the trade deficit declined by 14.6 per cent to Sh853.8 billion (2016).

There is something much deeper than these superficial observations. Though complexity may produce the appearance of chaos, yet there is a higher order most cannot see.

Markets can remain bearish for as long as they “desire”. However, keen trend watchers can always spot the signs when the “cycle-down” has petered out.

Two, studies show that human beings are pattern recognition machines. Interestingly, our brains are wired to form associations and then complete patterns.

Whether scientists think this is an illusion or not, “pattern recognition” is critical to investors’ ability to learn from past experiences and anticipate challenges as well as threats in the markets.

None demonstrates the power of cycles than Martin Armstrong, a “failed economist” and world’s top market cycles researcher.

Following his discovery that economic waves occur every 8.6 years, or 3,141 days, he correctly anticipated the 1977 upturn in commodity prices, the 1987 crash of S&P 500, Nikkei’s collapse in 1989 and Russia’s financial collapse in 1998. I must admit that his work has renewed my belief on the importance of cycles.

Lastly, I believe cycles are a divine blueprint from which everything is constructed. Summer and winter, heat and cold, seed and harvest time (Genesis 8:22) underlies my belief. As a result, history will always repeat itself though the actors change.