OPENING POSITION
July 2002
Booms and busts exist in stock market prices. One recent example was the Nasdaq bubble that peaked in early 2000, followed by the decline that has yet to show any signs of ending. If you go further back in history, you will see that the Dow Jones Industrial Average (DJIA) followed a similar pattern before the crash of 1929, as did the Nikkei index in the 1980s.
It's been more than two years since the Nasdaq bubble burst, and many are wondering just when the market will recover. The answer to that question may be found in the cyclical patterns of the market.
What causes cycles, anyway? Is it corporate profits? Is it interest rate fluctuations? Is it inflation? All of these make significant contributions to the occurrence of cycles. There are numerous and sundry theories that attempt to explain why cycles exist -- actually, whether they exist at all is widely debated among financial analysts. But is it necessary to understand the phenomenon behind cycles in order to trade the markets successfully?
To find out, STOCKS & COMMODITIES spoke with Jake Bernstein, an expert on cycles, so that he could shed some light on what goes into analyzing stock market cycles. The method he explained to us is intriguing: Don't focus on the whys behind cycles. Instead, take advantage of them, using analytical tools so you can time your entries and exits. So with that in mind, which tools should you use? You could try using the finite impulse response (FIR) and infinite impulse response (IIR) filters discussed in Contributing Editor John Ehlers' article "Zero-Lag Data Smoothers," starting on page 26. These filters are useful in reducing the lag to almost zero, making your entry and exit timing more accurate.
Another technique that can be used to identify cycles is the fast Fourier transform. This technique is extremely complex, but former S&C editorial intern and current Princeton student Amy Wu presents an introduction, starting on page 58.
So cycles do exist in stock market prices. Fortunately, the cycles and trends of the financial markets are a leading indicator of general business conditions, and traders should take advantage of them. We hope the analytical tools we discuss in this issue as well as others you may study will help you to answer the commonly asked question, the one that's got us all wondering: When will the market recover?
Jayanthi Gopalakrishnan,
Editor
Originally published in the April 2002 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2002, Technical Analysis, Inc.
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