TRADING TECHNIQUES
Incorporate Another Dimension Into Price Patterns
Hidden Rewards Of Cycles
by Mohab Nabil, MSTA
Head and shoulders patterns appear frequently in price charts. By
using simple cyclical analysis you can forecast not only the price target,
but also when that price will be reached.
Making a profit in the stock market is all
about timing. Despite this, many investors and analysts still do not treat
the dimension of time with the consideration it is due. The timing factor,
along with risk and reward, should be sufficiently weighted when trading
a specific pattern. To say that the reward-risk ratio of a given trade
is 3:1 is not completely accurate; this is because the time frame in question
has not been taken into account, and the time frame may make all the difference
whether you make three points or lose one point.
To trade profitably, you need to project the amount of time it will
take for the price to reach its expected target. By doing so, you will
be able to handle money management techniques in a more proficient way
and identify patterns that generate fast or slow price movements.
I will describe how to incorporate simple cycle analysis into price
patterns and identify head and shoulders formations. This will enable you
to determine approximately when price targets will be reached, which in
turn will help you construct a reward-risk-time ratio.
FIGURE 1: The vertical measurement of each cycle
or its height is referred to as the amplitude. The horizontal axis measures the time or duration of each cycle, measured from bottom to bottom.
JUST WHAT ARE CYCLES?
A price cycle can be defined as a recognizable price pattern that occurs
with some degree of regularity. Figure 1 displays the appearance of such
a cycle. A market with a 13-week cycle, for example, is one that has a
tendency to bottom every 13 weeks. The following terms are commonly associated
with cycles:
- Commonality - Summed cycles are a common factor among different
stocks and commodities. Cycles exist in the price action of all stocks,
and the cyclical component in each issue can be expected to have a similar
duration.
- Proportionality - There is a proportional relationship between
cycles. Longer cycles have larger amplitudes than cycles with shorter durations.
For example, a 13-week cycle will have a larger amplitude than a five-week
one.
- Summation - Price action is nothing but the summation of different
cycles with different durations and amplitudes.
- Variation - Cycles are just strong tendencies but can be subject
to changes or variation. When a stock typically has a 10-week cycle, but
for some reason shows a three-week cycle, this three-week cycle should
be expressed as a variation of the 10-week cycle.
...Continued in the September 2001 issue of Technical Analysis of STOCKS
& COMMODITIES
Mohab Nabil is currently working as chief technical analyst for Investia
Holdings for Financial Investments in Cairo, Egypt. He has published articles
on technical analysis for both Egyptian magazines and international journals.
After working hours, he trades the US equity markets and carries out his
own research. His main focus is pattern recognition and cyclic analysis.
He can be reached at mohab12@yahoo.com.
Excerpted from an article originally published in the September
2001 issue of Technical Analysis of STOCKS & COMMODITIES magazine.
All rights reserved. © Copyright 2001, Technical Analysis, Inc.
Return to September 2001 Contents
