Market cycle analysis is nothing new. When I first began learning how to trade, most of the books and articles I read were written in the early 1900s. Richard Schabacker and Charles Dow were my teachers. I have always thought that the basic gears of the market are basically unchanged. These men lived in a time before much of the regulation we see now in the financial markets, before computers and systems, before streaming data and charting, yet the reasons why what they did still works is because human behavior remains the same no matter what kind of technology is wrapped around it. It doesn’t take long before the successful trader realizes that at the core of trading is understanding her own mind and understanding the mind of the market.
Specifically, when it comes to market cycles, we’re talking about the mind of the market. The market is a gauge of psychology. Price does not represent the actual worth of a company or commodity or currency but rather the perception of its worth. This perception is affected by economic releases and fundamentals, and discounting these into price. Now if you think that somehow by not exhaustively researching this type of data you’re missing something, think again. All this is represented in price, and price action creates the cycles of the markets.
Cycles are representative of the psychology of the market. When traders and investors are greedy, markets rally. When they are fearful, markets fall. When they simply don’t know what to think, markets consolidate. It is vital that we understand this rhythm because it is how we will decide how to enter the market.
All strategies are based upon an underlying market environment. There are just four environments or cycles:
- Accumulation
- Distribution
- Mark up
- Mark down
Accumulation is one of two varieties of sideways markets. You’ll have an easy time knowing the difference once you understand the psychology behind it. Accumulation is the quiet market—it’s on the back burner. There’s likely little news or traders are waiting on news and no one wants to be the tall poppy. The range is narrow as the market creeps along sideways. What’s narrow? Remember, narrow is relative to the market’s current range and typical personality. Each pair has a unique price action behavior so what would be narrow on, for example, the USD/CAD can be very different when compared to the GBP/USD.
When you look at accumulation markets, the Wave should be sideways or traveling at what I call “three o’clock.” That’s right, just like the minute hand on your watch or a clock. When the Wave is traveling sideways you have a visual confirmation of the fact that prices are not trending higher or lower but rather have found a balance between support (buyers) and resistance (sellers).
Distribution is the second type of sideways market. The psychology behind distribution is not as simple as that of accumulation as the psychology behind it involves two distinct groups. Most commonly distribution is associated with the exhaustion of an uptrend and the turmoil often seen once a group of traders exit the markets as another group buys into the selling. What is different however is the fact that the move essentially is over or at stalling and therefore the market cycle “turns over” from the trend to a sideways direction.
Since there is not a bullish bias in forex as there is in stocks and futures, and by bullish bias I mean a predisposition to buy and look for an increase in the value of the market, you can also find distribution at the end of a downtrend as well. Again, it is simply representative of one group of traders exiting the market while another gets in, believing the trend is still in place. Regardless of where the cycle occurs, it is very much the collision of buyers and sellers, and it’s this collision that creates a more volatile and wider range. When the market enters distributions, the main difference you will notice, as compared to accumulation, is the volatility. The Wave will be sideways but can travel not only at the three o’clock angle but also at what is known as a “two to four o’clock angle.”
Two to four o’clock angles are unique to distribution and are more easily identified by what they are not rather than what they are. Let me explain. If a market is trending, it will be doing so at either a twelve to two or four to six o’clock angle. We already know accumulation is three o’clock. This means that its price action is sideways and the Wave is attempting to transition to three o’clock but is unsuccessful. We can be on the lookout for the two to four o’clock angle. It can’t be flat, and it can’t be trending. So essentially, it is a process of elimination, and we identify this two to four o’clock by what it’s not.
A few other things to look out for on sideways markets, whether it be accumulation or distribution, is solid support or resistance. “Solid” simply means that the touchpoints that make up the horizontal or static level are within five pips or less. More than five pips and the level can still be considered static, but now it would be “soft.”
Transitions between any of the four cycles are probably the toughest to deal with. These transitions will look as though one cycle is ending and another is possibly beginning. This is where you are most likely to want to have some sort of definitive way of saying that a new cycle is now set. But it’s not that easy. It’s not going to be as easy as my saying count three candles and if all three are traveling at the set clock angle you can say the transition is complete. But I just did, but that’s not all I want you to do. It’s more than the mechanics of counting candles. You must develop a feel for the rhythm of the market, and I know with time and practice you will. The market is just not that mysterious. It’s not more mysterious than human behavior, and while humans are certainly entertaining, we’re nothing if not predictable, and thus so is the market.
Mark up is just a fancy way of saying uptrend. Uptrends should be defined by support, which is a series of lower highs. Support is the key to maintaining an uptrend even within the context of pullbacks. Pullbacks or corrections are part of a healthy trend, and it’s these moves lowering within an uptrend that actually help perpetuate it. Think about it a moment. If you are waiting for an opportunity to buy into an uptrend, first I must say “kudos” because most people just buy the new highs and that is not an effective way to enter a trend. But if you are one of those smart and patient few who wait for a correction to enter a trend, then you know by your acting—buying into the market—you are in effect supporting the uptrend. An uptrend can be identified by the Wave traveling up at twelve to two o’clock. Once the trend is underway, it will probably seem unnecessary to confirm an uptrend with the Wave, but please do not let your guard down. It’s the slight nuance in the Wave, the transitions I explained earlier, that are so important to notice. The initial sign of an uptrend, its very earliest stages, are probably the most difficult to recognize without the assistance of a visual tool like the Wave. So make and keep the good habit: Confirm all trends consistently—no matter how obvious the trend may look—with the Wave’s clock angle.
Confirmation of an uptrend being intact within the corrections that occur can be easily done with the Wave. Look for prices to respect the support of the three lines of the Wave, most especially the bottom line. If prices break down through the bottom line of the Wave while moving up at twelve to two o’clock, that’s the first sign of transition or a potential turnover.
Mark downs, surprise, surprise, are a downtrend. The Wave angle you are looking for here is four to six o’clock. Downtrends are evidence of fear, and fear creates selling. Pullbacks within an uptrend are selling as well, but this is profit taking, and if it is true profit taking and the uptrend is intact, the lower prices of the correction will invite buying. Downtrends are different in their psychology because the emotion is much more extreme. People sell when they are fearful, and fear can come from bad news (most common) but also uncertainty. When in doubt, most traders will get out. When it comes to downtrends, gravity applies. Prices fall much faster than they rise. Because of this it is especially important that you stay sharp when waiting for bounces within the four to six o’clock Waves.
Trends in the forex are not as straightforward as trends in what I will call “single markets” like stocks and futures. If I am trading a stock, the price reflects the rise or fall of the perception of value of that company. The same can be said for commodity futures. If the market generally sees the value of crude oil is going up, it will generate buying. The consideration to buy or sell is determined by a single entity. It’s different when you are trading forex pairs.
They are called pairs for a reason. You are trading a relationship between two currencies. Uptrends and downtrends are not necessarily reflective of fear and greed in the way they are in “single markets.” Let’s examine this because it’s very different from the way most markets operate, since there are two separate markets that are being compared, and it’s the relationship between the two that is traded.
To understand trends in the forex market, we have to break down the pairs into the base currency and the second currency, so that we can understand on which half of the pair the fear is and which half of the pair the greed is. Pairs are quoted in a specific way, and for the purposes of Forex in Five trading and keeping with the most traded pairs, we discuss the same six pairs I listed earlier, the U.S. dollar–correlated majors and comm dolls.
