This article written by Oscar Cuevas was originally published in the December 2014 issue of Traders' Magazine.
Oscar Cuevas is a computer engineer and provides online webinars on Expert Advisor programming. He has also been a content developer and trading strategies programmer in Visual Chart for more than five years
Cycle Indicator. An Analysis Tool Based on the Phenomenon of Cyclical Movements
A fundamental aspect of trading strategies research is the detection of specific behaviours or patterns within the data stream studied. The purpose of this process is nothing other than trying to estimate, with varying reliability, the possible future movements based on those guidelines. Because financial data follow a temporal structure, time cycle based tools provide information of considerable interest. In this article, we will discuss one of these cases.
The Cyclical Movement Phenomenon
The evolution of prices of an asset usually follows a temporal sequence. When we talk about timing, we are not necessarily referring to each of the cycles having a period of similar length, rather we only refer to the fact that there is a relationship between a set of data for a period of time. Once this period of time is finished, the behaviour of the following data will probably show a different distribution.
Therefore, the key is to locate the beginning phases of each cycle, so you can take advantage of the information obtained from the study of the distributions. One of the existing methods to locate those phases would be the study of the price ROC (Rate of Change). Next, we will describe this tool and also the way to interpret it. Study of the Rate of Change in Prices The ROC, as the name suggests, shows the difference between the current price and the price given over a period of time, oscillating around zero depending on the direction taken by the price of the asset.
The interesting thing about this relies on the fact that, when a relevant change in the price movement occurs, the value of the exchange rate soars automatically. From that time, we consider that a new time cycle has started, since most variation between prices reflects consolidated forces favourable to the direction of thrust attack.
Note the speed with which this oscillator operates, since as soon as a bull or bear attack begins, the ROC is altered. This differs from other oscillators such as MACD or TRIX, which suffer from the lagging moving averages on which its calculations are based. The ROC follows a wave sequence, since the variation between prices stabilises sooner or later and marks the end of the open cycle. However, the fact that the ROC remains stable does not necessarily mean that the extreme point of the movement has been reached, simply that the change in prices remains constant. This means that once the new cycle is closed, the ROC loses its prediction value. To illustrate this we use the Visual Chart platform. Within this platform, we can find a tool that computes the function of the exchange rate, specifically the ROC Prices indicator.
In Figure 1, you can see a chart this indicator has been applied to. Here, we see an example of the above: The end of the cycle itself is not the point of exhaustion of the impulse but the location of a point of equilibrium where future events can be expected. On the basis of a tool to calculate the method we can evaluate the results obtained with the indicator and act accordingly.
As for the calculation process, the period of time that is often used to analyse the variation between prices depends on the type of study you want to do: When working in the short term the period is usually set on twelve bars while when working in the medium term the period used is at 25 bars. Since it is necessary to establish a specific time period, this can be a problem if the phases of accumulation last longer than expected. When this happens, it is normal that the exchange rate generates smaller cycles due to a lack of directionality. This problem is common with most analysis tools detecting trends. In order to filter bracketing movements we are going to include the volatility calculation in the study of the ROC.
John Ehlers says about the Cycles :
“The dictionary definition of a cycle is that it is ‘an interval or space of time in which is completed one round of events or phenomena that recur regularly and in the same sequence.’ In the market, we consider a classic cycle exists when the price starts low, rises smoothly to a high over a length of time, and then smoothly falls back to the original price over the same length of time. The time required to complete the cycle is called the period of the cycle, or the cycle length. Cycles certainly exist in the market. Many times they are justified on the basis of fundamental considerations. The clearest is the seasonal change for agricultural prices (lowest at harvest)…”
