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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