IFT Notes for Level I CFA® Program

R56 Technical Analysis

Part 3


3.5.     Cycles

Technicians use various cycles to predict future movements in security prices; even cycles in fields such as astronomy and climate can influence the economy and hence capital markets.  Commonly referenced cycles are discussed below:

Kondratieff wave: This is the longest of the widely recognized cycles, discovered by Nikolai Kondratieff in the 1920s. He suggested that Western economies have a 54-year old cycle. This cycle is also known as the K Wave.

18-year cycle: Three 18-year cycles make up the longer 54-year Kondratieff Wave. The 18-year cycle is often mentioned in connection with real estate prices, but it can also be found in equities and other markets.

Decennial pattern: This pattern connects average stock market returns with the last digit of the year. Years ending in 0 have shown poor performance while years ending in 5 have shown good performance.

Presidential cycle: This cycle in the United States connects the performance of the market with presidential elections. In this theory, the third year following an election shows the best performance.

4. Elliot Wave Theory

According to this theory, the market moves in regular waves or cycles. In a bull market, the market moves up in five waves 1 = up, 2 = down, 3 = up, 4 = down, and 5 = up.  (Impulse phase) and downward move occurs in three waves 1 = down, 2 = up, 3 = down (Corrective phase).

21 TA

Each wave can be broken into smaller waves over a shorter time period. Market waves follow patterns that are ratios of the numbers in the Fibonacci sequence. Hence, ratios of the numbers in the Fibonacci sequence can be used to set price targets while trading.

The Fibonacci sequence starts with the numbers 0, 1, 1, and then each subsequent number in the sequence is the sum of the two preceding numbers:

0, 1, 1, 2, 3, 5, 8, 13, 21, 34 …

5. Inter-market Analysis

Inter-market analysis is based on the principle that all markets are interrelated and influence each other. Here, technicians look for inflection points in one market as a warning sign to start looking for a change in another related market. To identify these inter-market relationships, a commonly used tool is the relative strength analysis. The relative strength analysis can also be used to identify the strongest performing securities in a sector and to identify the sectors of the equity market to invest in. Lastly, observations based on inter-market analysis can also help in allocating funds across securities from different countries.


Portfolio Management Technical Analysis Part 3