Technically Speaking, September 2007

This month, we feature excerpts from a discussion with Walter Bressert, a name synonymous with cycle analysis in the markets. Matt Caruso, CMT, recently spoke to Walt about his 30+ years in the markets.

Basically I look at my job as a trader and analyst using cycles to anticipate tops and bottoms in a market, and to generate high probability buy and sell signals in the direction of the cycle. It’s not that cycles affect markets, rather markets move according to the cycles. In other words – the cycles come first, they’re there and we use oscillators to click into that energy of the cycles. I don’t make the cycles; I have a program that finds them and identifies the cycle lengths in any market I choose to look at. So, my job is to try and figure out how accurate specific cycles actually are, and then how to integrate them on different time frames. My programs will identify cycle lengths, and after identifying the cycle lengths we shift into buying and selling by anticipating the time periods for cycles of specific lengths.

When I first started trading and became interested in cycles I thought they were the greatest thing in the world… but I kept losing money. I decided that I needed to get an edge on cycles to really know when there would really be a cycle bottom. Then I seriously started studying the markets… and what I found was that when I had a good history I could go back and make counts from cycle bottom to bottom to bottom etc… If for example, I look at a weekly chart and look back to get my bottom to bottom counts, then calculate cycle time periods that cluster, lopping off some of the shortest and longest time periods I have built a reasonably accurate Time Band. In the future when I get that same cycle count I’m going to expect the market to top and bottom in historical Time Bands…., and if it doesn’t then I may have a cycle inversion –in which a cycle tops when it should bottom, and bottoms when it should top. While cycles do make inversions they are most often “few and far between.”- it took me a lot of time and money to figure that out.

The mistake that many short term traders make is that they don’t pay attention to trend, and cycles give you a picture of trend.….Larger cycles set trend direction for smaller cycles…I start yearly when I have the data, for example we have the four-year cycle in the Dow (cycles are measured from bottom to bottom). Then, I drop down to a seasonal cycle, and then go into monthly, weekly, daily, and multiple intraday cycles. The key to this approach is that the longer-term time frames show you the trend for the shorter-term time frames. For example, if I am trying to enter long on a cycle in a 20-minute time frame, I have to be aware of cycles that are present in the next longer time frame, the 60-minute. The reason for this is that if the cycle on the 60-minute time frame is moving down, no matter how good the buy signal on my 20-minute time frame looks, the reality is that with my 20-minute cycle, the trend is moving down, as determined by my 60-minute cycle. By using multiple cycles I am constantly aware of the trend. Then, of course I’m looking to buy cycle bottoms and sell cycle tops. I have trading tools to show me when I can buy a certain bottom because the odds are 70, 80 or 85 percent that there is a bottom. 

Cycles can sometimes shift, but basically, I have not seen a significant change in any cycle lengths that exist in the many markets I track and trade, in both stock and commodity markets, as well as forex. I put something together 30 years ago called a Cycle Finder, which listed the individual cycle lengths for many markets and gave the dimensions for the timing bands. However, cycles do stretch and contract, and that is why I built Timing Bands, in which cycles can be expected to top and bottom in about 70% of the time.

The picture I want to get across is shown clearly in an example of the S&P 500 index (Figure 1). There was a weekly cycle low made on April 22, 2005. In the Dow and S&P 500 I am looking for an 18 to 25 price bar cycle, so for the weekly it would be an 18 to 25-week cycle. The cycles can shift, and that’s why I have timing bands. The way that I identify cycle tops and bottoms is by using oscillators that I’ve built. When I first started trading I became really excited about cycles, but would often lose money because I could see the flow of the cycles, and had a concept of them, but didn’t know how to work with them…..once I figured a few things out, things fell in place for me…. Finally I figured out that the way I was going to get it to work was that I need something to tell me when the market is going to turn. The first thing I built were timing bands… because I went back to my charts and saw that the markets made a move from bottom to top, or bottom to bottom of so many price bars. This gave me an edge, even though the accuracy of the market cycles was about 70%…So, about 70 % of the time, once I identified that cycle bottom, it was going to go up. When I identified the cycle top it was going to go down.

Figure 1 – S&P 500 (Nov 2004 – Apr 2006)

That April 2005 cycle bottom (4) is a particularly interesting picture. In working with cycles you must look at the longer time frames. When looking at the April time period I have a big picture move of three cycles within a single cycle. The sequence begins with a very significant double top prior to the April bottom. The market then comes down into the April bottom, which is above the significant cycle bottom in August of 04 and then starts back up again. There is a 26-week cycle bottom.

So coming back to April of 05, that cycle bottom was the end of an extended weekly cycle that began in August of 04. This particular cycle had 3 sub-cycles within it, which had bottoms in October 04 (see #1 in figure 1), January 05 (2) and the actual bottom of the nominal 20-25 week cycle in April 05 (3).

I call them nominal cycles because cycles contract and extend. In hindsight it is easy to see the picture; the market moved up in three steps. Starting from the weekly cycle bottom in August 2004 there was a sub-cycle of 11 weeks that bottomed in October. Coming out of that bottom we see a similar move that went up for ten bars and then down for three, then completed another sub-cycle in January of 05.

The next sub-cycle that is intra to the dominant weekly cycle went up from the January bottom, double topped and came down to give me a very high probability weekly cycle bottom in April of 05. I then had a buy signal the weekly price bar after the weekly cycle bottom (4), and surpassing the high of the weekly price bar with the buy signal conformed that the weekly cycle had bottomed.

I learned early in the game that I don’t want to make judgment calls. I need to have something that takes the pressure off. I found that when I was trading in the early years of my career I was always making judgment calls and it caused me to lose money. That’s why I started developing the mechanical signals, they take the pressure off and leave me free to evaluate what is going on and what I think is going to happen. At the low in April 2005 the picture is really clear because this cycle low dropped below the previous sub-cycle low in January 2005 and gave a buy signal the next price bar, and that signal was followed by another buy signal the following price bar as well (5, in figure 1). My approach is to have multiple entries to confirm what I’m doing… so I have different entry signals that overlap. This particular bottom in April 05 had a buy signal followed by a continuation and then another buy signal. I had two buys coming off that bottom which is always a good picture for a probable up move. Everything is probable, nothing is certain.

As you can see, the market did move up for 14 price bars, and made a top that was quite apparent – mainly because the blue 10 doublestoch oscillator turned down (6). (Ed note: the color chart is available online at www.mta.org.) When that oscillator turns down and prices take out the low of that price bar, the odds are approximately 70% that I have a cycle top. So I always look at the odds, and am not trying to fudge anything, I know I can lose money if I don’t wait for my signals. Therefore, I let the market tell me what is going on relative to the trading tools that I’ve developed, and the cycles that I work with.

I then saw the cycle high in July of 05, which is confirmed by taking out the low of the price bar in August. Once the market takes out the low of the sell signal in August, I have a confirmed 70% top…. An approximate 70% probability of having a top is pretty good just based on that, and then of course, I’m using other technicals such as the fact that prices are close to the upper Keltner band. I’m also using another signal I developed called a B-line. I have what I call a cluster near that top of different indicators which is saying that we are making a top. If the market takes out the low of the price bar with the sell signal – taking out the low is the key – the odds are 70% to 80% that the cycle top is in place.

Therefore my sell signals confirm tops. I have three or four sell signals that confirm a high probability top, and use the high of the cycle as my initial exit. As this cycle moved lower I would prepare to buy the bottom. It came down to make a swing low in September and swing lows frequently develop into buy signals, as swing highs frequently develop into sell signals. Therefore I watch them very closely and see when they correlate with my oscillators. The September swing low did correlate reasonably well with an oscillator but I had other indicators pointing down. Although the market moved up the week of September 9th, the market did not surpass that high which is crucial, because from my viewpoint that is a failure pattern, which is very significant and the market then has a high probability to continue in the other direction. What it did was fail to surpass that high, made a swing high, and then dropped into a cycle bottom. To be honest, I do not use the weekly to buy and sell, but to give me the bigger cycle picture. With “Deep Pockets” you could trade the weekly chart and have similar results to what I have on the smaller time frames, but you would just be winning and losing larger amounts of money.

When we finally come to the October cycle bottom, I get three buy signals, and I wait for the next bar to confirm the buy signals by surpassing the high. As the cycle keeps moving lower, I watch the oscillators. When they turn up I have a buy because the cycle count is right, and if I get a mechanical buy signal the odds are 70% I have a bottom. Then I got a b-line buy which is a second buy signal and the market was telling me it was going to go up.

I always have an idea of seasonal patterns; which you need to especially trade the grains. I keep the seasonal pattern in the back of my mind, but my cycles tell me much more than the seasonal pattern. The cycles will top at the seasonal pattern top, therefore it’s a question of timing, and that is why my timing bands are so important. Usually, I’m looking for the signals to occur in my Timing Bands. I also have what I call buy and sell dots which also show me to anticipate significant tops and bottoms. I’m saying this because I’m not just relying on the Timing Bands. I could be off balance and not quite figure something out, and suddenly these buy and sell dots will start appearing and telling me I’m coming into a cycle bottom or top. I use multiple oscillators for different things, analysis and trading patterns.

Buy and sells dots come from a particular indicator that offers a high probability of correct activity, as I would put it. I also use multiple time frames for the oscillators. In the example of the S&P 500 weekly charts I have a 30 doublestoch oscillator  that gives me an evaluation of what the 10 doublestoch oscillator is doing because it’s longer term….. Let me digress a little bit. I was using the 5 doublestoch, which is very fast moving, and I was fast moving in those days. Then as I got hurt more and more I decided that I had to find something besides the 5 doublestoch because, although it does give good buy and sell signals, it can be very wrong at times. I then developed other oscillator, that’s where I developed the 10 Doublestoch and the B-Line. When all of the oscillators line up together it is very significant, and fortunately, they do so often.

Any oscillator turn is showing a change in energy. A 5 doublestoch has a shorter term energy and the markets will make smaller moves than with a 10 doublestoch. My 30 doublestoch is for the big picture, and I use it to evaluate the patterns I  see in the 5 and 10 doublestoch, and the b-line. When I have my 5 and 10 doublestoch, along with  my B-line coming to bottom or top, I have a high probability that the market is going to reverse. It is going to reverse because those oscillators show  me the energy of the cycle. I realize that what I just said is rather hard to explain. I used to teach my approach in a three-day workshop from 8 in the morning until dinner and then another 3 hours, but I don’t do that anymore.

It is possible to obtain price projections from cycle bottoms or tops. I have one pattern that I call a “mid-cycle pause price projection” which will give fairly accurate price projections for tops and bottoms. I worked long and hard to get that pattern, they are not easy to find. Since there are cycles in the markets, if you know the cycles you can get a decent idea of what is going to happen coming out of a cycle bottom especially if you trade in the direction of the trend – which I always do now. I have another indicator called the “trend and momentum indicator” that I developed a number of years ago that shows trend well. Before I created that indicator I really didn’t have a handle on trend, the trend to me was higher highs and higher lows. The trend momentum indicator uses direction and colors, and I finally understood. I could combine cycles with trend and it was phenomenal. The trend momentum indicator is based on multiple moving averages along with some other stuff.

When I enter a position I look to make a “three portion” trade. The first part I take off for a short term profit, I get out really quick. The second part is for a longer term profit, maybe taking it to a cycle top. When I get into the timing bands, they are telling me that it is a good time for a cycle top or bottom depending on what the case may be, but I use a mechanical sell signal to get me out. If I don’t get that sell signal, I then look for a swing low to get me out. I use swings in everything that I do, cycles are just bigger swings. The third part is for the long term picture and that’s where my trend momentum indicator comes in, it gives me a real edge on trend.

All too often when people are trading they take the money and run, then along come some bad trades and they get killed. I’ve been using this for 30 years and it works. So much of trading is balance. The method I have put together is to balance me. I’ve found that if I’m out of balance and I can’t connect, I’m going to make a mistake and lose money. That’s why I decided to take a quick profit on my first portion because if I do I then have money in my pocket. On my second part I may make a lot of money, or I may not, but either way I’ll have a good stop. The third part I leave run for the big moves, and I’ve made a lot of money with this concept.

I don’t have emotions when I trade. I lost a half a million dollars when I started. I couldn’t keep going like that, it was horrible. I paid my dues and realized that I don’t want judgment calls. I now have 70% judgment-free trades.

When I first started, I had a lot of losing days when I found I had to just get into a hot bath and lay there for half a day. I was shattered….. My cycles were supposed to do this and that and then I thought, “wait a minute let’s take another look here.” Then I started using stops. In my early years (30 years ago) I thought my job was to identify cycle bottoms and get out near cycle tops and vice versa, and that was how I was basically trading the market. The problem was that you can get really hurt, and I did, and I lost quite a bit of money. After four or five spectacular busts, I figured there had to be a better way.

That was my initial learning experience. I was not going to give up. I had bad days, weeks, and months but wasn’t going to stop trading because I knew that cycles, and good money management, were the keys to success, I could feel it – and it was cycles. Over time I learned to control my fear and greed.

Determination, on the one hand, separates successful and unsuccessful traders. On the other hand, traders who understand the price bars, trading patterns and cycles can trade technically. Fundamentals are just too complex. I can teach anyone to trade technically. Once you understand it for one market, you can carry it out in all the markets. Those who take a technical approach to the markets and stick with it are, in the initial stages, in a learning experience. At some point they will realize that their learning experience is finished and that they’re in control. Until that happens, they are going to lose more money then they make. The worst thing that can happen to someone is that they make a lot of money when they start trading. Everyone I’ve seen do that eventually did very poorly. They thought they understood it and they thought it was easy, but the market wants the money back.

You have to know the fundamental picture, and stand aside for the big reports. It’s not easy to develop a fully mechanical system based on cycles, believe me. As a matter of fact I developed one for the Euro called Euro Trader. All along, as I’ve been working with the market, I’ve been trying to develop mechanical buy and sell signals that I put together into a trading package that I traded myself. I then tried to trade it mechanically and it didn’t work because the brilliance of the brain cannot be thrown into a group of price bars without some kind of connection. The connection from my viewpoint was cycles and oscillators.

We traded it short term, intra-day, rather then tried to do something longer term such as daily and weekly. We spent probably two years on it and did extensive backtesting where we learned invaluable information on what can and can’t be done with backtesting. I doubt if anyone has gone into it in as much depth as we have. When we were done, we made money in the market, and it’s capable of making money today.

We use multiple cycles. We went back in time and really looked to see what happened. We found some very significant patterns that occur time and time again to get decent profits. That’s what made the difference; we didn’t just put together a few oscillators to see what we’d get. I tried that and it doesn’t work. The system was put together piece by piece; and each piece had to be profitable over the longer term.

For technicians entering the business, find a mentor, or find an approach that you feel comfortable with, ideally both. Search to see what makes sense to you and if you see something you think works, start paper trading. Paper trading helps you get a feel for trading, in the real world you are going to lose a lot more often. You should paper trade though because that gives you the skills to make a little money in the market. If you just jump in, you’re going to have a much harder time. 

There is so much more information and trading programs out there now. When I started there wasn’t really much on technical analysis. It took me awhile, but I learned there is a big difference between analyzing the cycles, and trading the cycles.

For more information about Walt and his work, readers can go to www.walterbressert.com.