Cycles are recurring patterns in a given market. The area of cycles has been intensely researched for almost 100 years. In fact, there are organizations dedicated to the study of cycles. Cycle-based trading has become a hot topic because of the software now available for analyzing financial data and for developing trading systems. Because of this software, we can now see how a market is really composed of a series of different cycles that together form its general trading patterns. We can also see that the markets are not stationary. This means that the cycles in a market change over time. Change occurs because the movements of a market are not composed solely of a series of cycles. Fundamental forces, as well as noise, combine to produce the price chart.
Cycle-based trading uses only the cycle and the noise part of the signal. There are many tools that can be used for cycle analysis. The best known are the mechanical cycle tools that are laid over a chart. An example is the Stan Ehrlich cycle finder, a mechanical tool that is overlaid on a chart to detect the current dominant cycle.
Among the several numerical methods for finding cycles, the most well known is Fourier analysis. Fourier analysis is not a good tool for finding cycles in financial data because it requires a long, stationary series of data—that is, the cycle content of the data does not change. ...