Many investors could benefit from a fluctuating nature of the stock market. A semi-cyclical nature of the market is a bad surprise for some investors but others know how to take advantage of the cycles.
One of the market characters is that it has powerful and pretty consistent cycles. Its performance curve can be considered as a sum of the cyclical functions with different periods and amplitudes. Some cycles known by investors for long, for example, four-year presidential cycle or annual and quarterly fiscal reporting cycles. By identifying the cycles it is possible to anticipate tops and bottoms, as well as, to determine trends. The stock market cycles can be a good opportunity to maximize return on investments.
However, it is not easy to analyze the repetition of typical patterns in stock market performance because often cycles mask themselves; sometimes they overlap to form an abnormal extremum or offset to form a flat period. The presence of multiple cycles of different periods and magnitudes in conjunction with linear and non-linear trends can form a complex pattern of the curve. Evidently, a simple chart analysis has a certain limit in identifying cycles parameters and using them for predicting.
Any predictive method has own limit. The major obstacle in using cycle analysis is a cycle instability. Due to a probabilistic nature of the stock market cycles, the cycles sometimes repeat, sometimes not. In order to avoid excessive confidence and, therefore, losses it is important to remember about a semi-cyclical nature of the stock market. In other words, the prediction based on cycle analysis cannot guarantee 100% accuracy of prediction.
One of the techniques to improve a prediction accuracy is back-testing. It is the process of testing prediction on prior time periods. At the beginning, instead of calculating the prediction for the time period forward, we could simulate the forecast on relevant past data in order to estimate the accuracy of prediction with certain parameters (and then adjust these parameters).
To discover different patterns in the market movement, including cycles, investors use different software tools. One of the tool is Stock Market Predictor SMAP-3. It is able to extract basic cycles of the stock market (indexes, sectors, or well-traded shares). To build an extrapolation, SMAP-3 uses the following two-step approach: (1) applying spectral (time series) analysis to decompose the curve into basic functions, (2) composing these functions beyond the historical data.
As example, the chart below shows S&P-500 forecast for May 17 - June 2, 2010. The calculation has been performed using SMAP-3. The forecast is the following: downtrend may continue until May 21, then a reversal to uptrend until June 02.
Computational details: regular mode (auto); number of line for spectrum analysis - 48; used historical data period - 4 months (from December 17, 2009 to May 14, 2010); back-test deviation - 1.11%; spectrum lines and fitting charts -
In conclusion, the stock market is an alive system - around can be joy or fear but its buy-sell pulse always exists. To discover different patterns in the market movement, including cycles, investors use different software tools. Sometimes, these computer tools are called "stock market software." Also, stock market software tools help investors and traders to research, analyze, and predict the stock market.
Nothing in this piece or blog should be construed as investment advice in any way. Always do your own research or/and consult a qualified investment advisor. It is wise to analyze data from multiple sources and draw your own conclusions based on the soundest principles. Be aware of the risks involved in stock investments
© Alex Shmatov. Published with permission of the copyright owner. Further reproduction strictly prohibited without permission.