Trading insights
Cycles are a crucial part of technical analysis and provide valuable insights into market trends and price movements. Many investors only look at price, but time is just as important—perhaps even more so. By integrating cycle theory with supply and demand zones, Fibonacci levels, and price action analysisr, traders can better identify potential trading strategies and make informed decisions.
In this blog, SDC Trader explains everything about cycles, where price could reverse (based on supply and demand zones and Fibonacci levels) and how to achieve a perfect trading setup with sufficient risk-reward. Whether you are just starting out or are an experienced professional, understanding these principals can be an essential tool for creating good setups and growing your wealth.
Cycles and trading
Conjuncture refers to the change in the growth rate of the economy or production over a specific period. The average growth over a long term is called trend growth, but in reality, growth does not follow a straight line; instead, it exhibits waves of expansion and contraction: a cycle. A cycle is a recurring pattern over time, where increases and decreases alternate. Each cycle has a unique duration, causes, and effects on the economy. Understanding these various cycles is crucial, as it aids in grasping the complexity of economic developments and anticipating future changes. The most well-known cycles include the Kitchin cycle (3 to 5 years), the Juglar cycle (7 to 11 years), the Kuznets cycle (15 to 20 years), and the Kondratieff cycle (45 to 60 years).
However, the mentioned cycles are long and therefore less relevant for traders, who focus on shorter cycles to identify potential setups and assess whether a situation may be bullish or bearish.
Cycles theory of Bressert
SDC Trader utilizes the cycle theory of Walter Bressert, who discovered that markets (regardless of the type of asset or timeframe) tend to form bottoms at regular intervals. Many investors primarily focus on price, but the aspect of time is equally crucial, if not more important.
By studying cycles on a candlestick chart, you can gain a sort of compass that helps you determine the current market situation and where it may head in the future. It’s important to note that this is not gambling, but rather the formulation of the most likely scenario. On most financial markets, a cycle typically lasts about 20 periods, with a variation of 15 to 25 bars, measured from bottom to bottom. This phenomenon is applicable across all timeframes and markets; it can be used on monthly, weekly, daily, hourly, or 15-minute charts, and thus for stocks, indices, crypto, and commodities. This cycle theory is valuable for both day traders and swing traders, as it provides better insights into market behavior and allows them to refine their strategies.
By understanding these cyclical patterns, traders can better assess opportunities and manage risks. Bressert's cycle indicator is an excellent tool for more accurately estimating potential cycle bottoms. It is a Double Stochastics indicator—a variation of the regular Stochastics indicator—and it signals almost all market tops and bottoms. The indicator itself moves in waves between 0 and 100. At tops, the value is well above 70, with 85 being my minimum threshold to signal a top formation. At bottoms, the value is significantly below 30, and I use 15 as my threshold.
The following example illustrates the most recent daily cycle bottoms of Microsoft.
What phase of the trend is the stock in?
Now that we can estimate the potential length of the cycles and identify tops and bottoms using the cycle indicator, it's important to understand how these relate to the trend, which can be either bullish or bearish. This requires thorough trend analysis, and we need to break down the cycle.
One cycle consists of two parts. Both parts are essentially the same: they begin with an upward movement to form a top, followed by a decline to form a bottom. The end of the first half of the cycle is referred to as the mid-cycle low, while the end of the second half of the cycle—and thus the end of the entire cycle—is called the cycle bottom. The position of the mid-cycle low is crucial for determining the trend in which a stock is situated, but more on that shortly.
However, it’s important to note that the cycle tops do not always occur neatly in the middle. The earlier a top forms, the more bearish it is, while a later top is more bullish. An early cycle top to the left of the midpoint is referred to as “left translation” and is considered bearish; a late cycle top to the right of the midpoint is called “right translation” and is viewed as bullish.
During an upward trend, you typically see tops that are positioned to the right of the midpoint. The cycle is predominantly bullish, with higher highs and higher lows. This pattern is often reflected within the two phases of one cycle. In the first half, a higher high is established, and the pullback to the mid-cycle low results in a higher low. In the second half, this process repeats: another higher high is formed, and the cycle bottom becomes yet another higher low.
In contrast, during downward trends, the tops are usually found to the left of the midpoint, showing the opposite pattern. In the first phase, a lower high is made, followed by a decline to the mid-cycle low that is lower than the previous cycle bottom. The cycle remains bearish in the second half, again with a lower high followed by a lower low.
Here is an example of a “the trend is your friend” chart, illustrating a negative trend for SolarEdge, with each instance showing a lower low and a lower high.
How to Identify an Ideal Setup
Now that we’ve analyzed which phase a stock is in, we can focus on executing a trade. The goal is to buy around cycle bottoms during an upward trend (going long) and to sell around cycle tops during a downward trend (going short). While the cycle theory provides support for determining the ideal entry point, price action is the leading factor. The cycle offers clues for finding good trade locations, while price action indicates when a bottom or top is likely to form.
It’s advisable to combine cycles from multiple timeframes, as cycles on higher timeframes are always dominant over those on lower timeframes. This is known as "multiple timeframe trading." It’s a powerful principle that can provide valuable insights into potential price movements. However, multiple timeframe trading requires thorough training, as it is more complex than it may initially appear.
I also integrate cycles with supply and demand zones. When a cycle indicates a bottom signal and is positioned just above or within a demand zone, the location for a bottom feels “logical.” The same applies in reverse for a top signal just below a supply zone. Additionally, I check for nearby Fibonacci levels; a pullback often halts around the 50% or 61.8% Fibonacci line of a previous move. An upward movement is typically in relation to a preceding move as well. Lastly, I examine the position of my most commonly used moving average, the MA21. If it is close by and could potentially provide support or act as resistance, you are very close to achieving an ideal setup.
Nvidia's New Daily Cycle and Ideal Setup
At the beginning of 2024, Nvidia started a new daily cycle just below the MA21. After a brief correction, a new bottom was established at the end of January, and the price rose significantly again. This upmove was followed by a reasonable pullback. With the indicator at a low point and the price between the 50% and 61.8% Fibonacci levels—along with the proximity to the MA21—this presented the perfect setup to go long!
What Risk-Reward Do I Aim For?
Now that we’ve determined which phase of the trend a stock is in and identified an ideal entry point, when should you actually enter the trade? Calculating your risk-reward ratio is crucial. For optimal risk-reward, you must wait until the price reaches your setup. If you enter above those levels, your risk-reward ratio will be considerably worse. Trading is a skill; swing trading is a marathon, not a sprint. It’s also a mathematical exercise—it's about the return you achieve over many trades, not just the outcome of the next one.
For your risk-reward calculation, you need three things:
What is your entry level? This has been thoroughly discussed above.
What is your price target? Ensure that your target is realistic and not one where, hypothetically, the price needs to double to hit your goal.
What is your stoploss level? Where will you honestly admit that your vision was wrong, or, to put it more positively, where has your setup been invalidated?
For a swing trade, I aim for a minimum of twice the reward for the risk taken, ideally even more. Why? It's the maths.... For example, if I take three trades based on this risk-reward ratio of 2, and I close two losing trades and one winning trade, I am still break even; I incur a loss of 2 (from two trades) and gain 2 from one winning trade. As I improve my risk-reward ratio or increase my winning trade percentage, I will see a profit over multiple trades!
After an impressive rally to new highs, CrowdStrike traded sideways since early June. On July 9, a minor new high was set, but it was quickly sold off. The subsequent two-day pullback dropped below the previous trading range, creating a short setup. An entry after losing the MA21 after the 50% Fibonacci level failed to regain, with a stop loss placed at the top of the body of the last red candle (as, in a bearish scenario, no new highs should occur), aimed for a recent daily demand zone. The risk-reward ratio was nearly 3.75 which was sufficient for a swing trade. That the price eventually dropped to even 200, making the potential reward 10, should be seen as a bonus.
When to Pull the Trigger?
Once you’ve gone through all these steps, the signals are all green to enter the trade without intense emotions; now, it's time to wait for the trigger. By analyzing price action, you can determine who has control: the buyers or the sellers.
Price action analysis focuses on identifying who has control at any given moment and when that control shifts from buyers to sellers or vice versa. This makes price action an essential part of the trading method. In principle, you can trade based solely on price action, without relying on any indicators. Indicators often lag and respond slightly later, while price action is "real-time." However, I use indicators to support the narrative that the candles provide.
In this chart of Apple from early 2024, it’s clear that sellers have control in the left half, as every rally is sold off. Each decline is followed by a bounce to a lower high (indicated by the red arrows). When a low was established in mid-April at the circled point, it was not yet clear, as another lower high followed at the end of April. A first sign that buyers were trying to take control was the absence of a new lower low. When the price gapped up above the previous recent high in early May, it became clear that the low had been set. From that moment on, every dip was bought.
As you can see from this blog, a thorough analysis precedes any setup. What is the trend? In which phase of the trend is the stock? Is there a level where the price could reverse? What is the risk-reward ratio at that level? Is there a trigger? These are all questions that need to be answered before a trade becomes a well-reasoned and calculated opportunity. I hope this has provided you with clear insights into what to pay attention to.
If you're not confident in your ability to draw the right zones, or if you don't have the time or desire to conduct your own research, you can certainly take advantage of the benefits that a subscription with SDC Trader offers; the homework is already done, the zones are marked, and you only need to place the limit orders with your broker. Click on these two buttons for more information about subscriptions or to sign up directly.
