We have recently had a number of inquiries about our Cycle Forecaster, and have found that generally people are a little confused about what it represents and how to use it. Out of all of our tools, the Cycle Forecaster represents the one that is probably the most difficult to learn to use. Hopefully, this showcase will make trading with this indicator a little clearer for both our current and future customers. Below is a chart of Lumber futures:
There are basically two ways that we recommend using this tool: as a true price forecast, and as a turning point detector. When most people hear the word "forecast", they immediately look at this tool and are disappointed because it does not look like an overlay of price. Remember that the forecast is of future cycle action, not of price. Since the cycles we use are detrended, this means that the magnitudes of the swings in the Cycle Forecaster will not correspond to the magnitudes of the swings in price. For example, look at area 3 on the chart above. Notice how the sharp downmove in the Cycle Forecaster really didn't show up as a sharp down move in price. In fact it was a very brief 1-week decline that turned around and ended before the forecast said it should. That's what a contra-trend cycle looks like. Even cycles need to pay attention to the major trend. Look what happened next. We had an upmove in the Cycle Forecaster (about the same magnitude as the dud down move we were just talking about) and price exploded upward violently. Upward cycles in an uptrend will be exaggerated compared to the forecast line. Ignoring the trend is the first stumbling block when trading off this forecast.
The second stumbling block when trading any forecast is determining if the market is currently following the forecast. There's no reason to use a forecast if the market is ignoring it, so it is always a good idea to look at the last 20-30 bars and see how well price and the forecast match up. For example, the area between numbers 1-3 on the chart above does not really seem to correspond very well with the forecast. This means that there are other influences in the market and the cyclical component of price is not as strong as we would like. Now look at areas 5-8. The correlation here is much better, and should be obvious if you just pay attention to the shapes of the two data streams we are looking at. At times like these, we can be more comfortable and give our forecast a higher weighting in the analysis we are doing.
Those are basically the two things to watch for when trading the Cycle Forecaster as a pure forecast. There are no hard and fast rules with this method, and it takes some practice to learn how to listen to this indicator. If you put in the time, it can give you valuable insight into what the market may do next.
The second method for using this tool is the one we recommend to start out with. It eliminates much of the subjectivity inherent in the method described above, and does not take a great deal of experience to implement. This method works as follows: 1) Watch the Cycle Forecaster for major turning points. 2) When a turning point is found, check other tools for a possible trade.
If you look at the chart above, you'll notice a number of vertical red lines. These are drawn through the turning points on the Cycle Forecaster and correspond with good times to look for a trade. Remember that the location of these red lines are known around 4-5 bars before they occur, so we have a period of time to decide whether or not we would like to do anything.
This chart shows the same price data, but with the Cycle Forecaster removed. We have left the numbers on the chart, which correspond to the turning points in our forecast. Let's go through these points one by one to see how this would have played out if we had actually been trading this way in real time. We will use MA_Momentum and Exhaustion Bars as our supplemental timing tools.
1. This was a good call by the forecaster, but our other tools are not really supporting a trade here so we have to pass.
2-3. We have got an ExBar sell and bearish divergence very close together near this area, so we would have been looking to sell. However, if you have read our old showcase page about MA_Momentum, you'll know that there are other signals besides divergence to watch. In this case, MA_Momentum was forming a nice descending triangle after and ExBar buy. Classical technical analysis on oscillators is an interesting form of analysis, and can sometimes produce very accurate signals. In this case, we would have known to get out of our short and reverse to long on the breakout. Remember that we're only paying attention to these signals because they fall within a turning point zone as defined by the Cycle Forecaster.
4. This marked the start of the violent portion of the upmove, but there were no supporting signals besides those listed in 2-3. After the triangle in MA_Momentum, only the most stubborn traders would have still been short from 2.
5. We've got an ExBar sell and bearish divergence in our momentum curve. The Cycle Forecaster (from the first chart) is tracking very well, so we can use its direction as a weight in our analysis. In this case, everything is pointing down. Note that there was an ExBar sell about two weeks previous to this point but we don't need to bother with looking to go short there because there is no Cycle Forecaster turning point. Only take trades at those areas given by the forecast. The rest of the time just worry about controlling losses and moving trailing stops.
6. This was a good call by the forecaster, but there are no ExBars and our momentum curve is a little unclear. If you're greedy go ahead and get out if you have to, but don't take any new positions at this time.
7. This is a similar situation to 6. Nothing to do but watch.
8. The ExBar buy, bullish divergence in momentum, and later wedge breakout tell us to go long. Hopefully we would not have bought on the open after the limit day! At this point, assuming we were long, it would be time to monitor the stops and watch the Cycle Forecaster for another point.
So you can see that this second method is fairly straight forward. The hardest part is to remained disciplined during those times when the Cycle Forecaster is not at a turning point. This was a long showcase, but hopefully the value and usage of the Cycle Forecaster will be clearer. Happy Halloween.
Back to Archives