October Theme Of The Month: Trading The Market Cycle

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What is a Market Cycle?

The patterns we see in the market are a reflection of human psychology. Because of this, the market and its leadership follow a template that is cyclical, which if you study history occurs again and again.

These cycles characterized by uptrends and downtrends can be identified using systems which allow us to maximize our profits and exposure in positive environments, and tailor back exposure and protect profits during negative environments.

The market cycle is composed of two different layers. The first is the technical layer which involves the amount of liquidity available in the marketplace. We can use the Bolded Pivot System to identify these liquidity levels. The second layer is the Human Psychology Layer which causes the shorter term fluctuations in the market. This layer is driven by fear and greed as market participants either accumulate or distribute stock. After a strong move up, market participants will often take profits, locking in gains and causing a pullback.

Throughout history, market cycles have played out over and over again. To trade sustainably, you need to have a system that can identify and weather the market’s movements.

Table of Contents


What is the BP and IP System?

The BP system is a process that we have developed over the past few years that incorporates liquidity, volatility, seasonality, sentiment, and market structure. The outputs are clear levels where we expect directional movement. We can use the system to define both the start and end of various market cycles. Very simply, when the bolded pivot is reclaimed a new upcycle begins and lasts until we break below it.

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Ray developed the BP system after studying various market indicators as well as current market structure.

The Bolded Pivot is the most important level in the system. Below the BP the market is volatile and unlikely to hold. It is very difficult for both swing traders and position traders to make progress. Above the BP, liquidity returns to the market and progress can be made.

The Intermediate pivots provide a more granular look at the market and are useful for swing traders to time entries and align their actions with key market levels where we expect directional movement. Absolute IP respect when we are below the BP can be one of the first indications that a new market cycle is developing.

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Although the IPs can be very useful for swing traders, position traders should simply focus on the longer term signal of the BP as well as whether we are trending above or below the 10 week moving average on the major indexes.

As with any system, it’s essential to understand that although it provides an edge, it is not absolute. There will be times when BP reclaims fail or provide false signals. However, in the history of the BP, we have found that it usually provides indications of a new market cycle up to 2 days before the classic CANSLIM follow-through day and also often provides a better view of the liquidity and volatility of the market.

We are continuously working to improve the system and are currently working on a version for both the Nasdaq and Small cap markets. These would provide information about rotation between different portions of the market.

For an in-depth explanation of the system we highly encourage you to check out the Market Cycle Mini Course.

How do Market Gauges Help Us Identify Market Cycles?

Market gauges are key stocks that institutions are currently supporting/accumulating. We choose these stocks by identifying key growth names as well as the best stocks in the current market leadership.

TSLA and GOOGL are good stalwarts because of their status as institutional favorites and also their weighting in the indexes. 

We also choose the top dogs in the current potential leadership groups. For instance earlier this year both FSLR and ENPH were perfect representatives of the solar group which was leading.

The process is somewhat discretionary but the key point is that these gauges are leading indicators of the risk appetite of institutions. If they are being supported and holding key psychological levels such as round numbers, the environment is positive and other traders will work well. However, if they are breaking below levels that shows that the environment is deteriorating and you have a reason to be more conscious.

Trading the Market Cycle

Let’s now go through the full cycle and the actions you should be taking during each part. 

First, when the market is below the BP you should be limiting exposure or taking select shorts. As the market declines, the BP will adjust downwards setting the level for liquidity to return to the markets. Stocks showing relative strength when we are below the BP are to be noted but they are also suspect. Trying to trade these properly in choppy markets can be like finding a needle in a haystack.

There are two signs that you should look for that may indicate that a new upcycle is beginning and that you should be ready for a BP reclaim.

First, the market will begin to respect downside IPs on an absolute basis. This means that the market may fall towards that key level but rallies off of it before any undercut occurs. This is a signal that a bid is returning to the market.

The second sign you should look for is decoupling. Watch the three key watchlists closely for an indication that they are beginning to ignore the actions of the general market. When we are in a downcycle and the indexes make new lows or gap down severely into the red, be on watch for the watchlists to be performing significantly better. This shows that even though the market indexes are being pushed downwards, institutions are stepping in and accumulating promising stocks.

The Cycle Begins

The cycle truly begins when we reclaim the bolded pivot on a closing basis. At this point liquidity is improving and we are at the very beginning of a promising period. 

There are two different situations where a BP can be reclaimed.

The first is that we are experiencing a rally from oversold levels and there is a lack of clear leadership or PLGs. Even in this case, there is still a lot of potential for select trades shorting the SQQQ. However, expectations should be lower than if there are many setups and promising stocks.

The second situation occurs when we are seeing breadth improvement, there are many stocks on our watchlists acting well and setting up entries, and there are multiple PLGs. In this case your stance should be more aggressive.

When the BP is reclaimed on day 1, I go short the SQQQ. This is the first trade that sets the ball rolling and likely provides me with the cushion required to increase exposure. I short the SQQQ instead of going long the TQQQ due to the fact that the fee structures of these leveraged instruments are set up in such a way that shorting the inverse will provide better returns.

At this point the market has to prove itself. I want to see immediate traction and profit. If, on that day one the market initially reclaimed the BP but closes below it, I sell that first position.

The first 1-3 days of a new cycle are the best risk/reward opportunities for taking advantage of the move. If I receive immediate traction on the short SQQQ position I snowball that profit into a position in the most promising leader.  Keep careful track of my open profit and ensure that worst case I lose 2% of each new position. 

There have been plenty of times where even that first position has gone against me or I end up giving up a lot of profits and we drop back below the BP. However, the system has a clear edge that I have studied and this risk is well worth the potential reward if the cycle truly takes hold and we quickly move higher.

Each new position is financed by the open profit of existing positions, this allows you to quickly increase exposure and take advantage of that first 1-3 day window.

Stress Test 1

Stress tests are a natural part of the cycle where profit taking takes hold and we see the market test the strength of the rally.

The first stress test generally occurs on day 4-6 of the cycle. How your portfolio, watchlists, the leaders, and the market as a whole respond to this bout of selling provides valuable information about the strength of the rally.

If for instance, your positions all suffer large drawdowns together and hit raised stops, then the market is likely weak and we will return below the BP.

However, if the market holds firm and recovers from the initial weakness we should expect the rally to extend further.

If I position myself well during the 1-3 day window I look to anticipate this first stress test and maybe even sell initially into it. The stress test often occurs when we open near an IP and can expect directional movement. 

When day 4-6 rolls around you want to be ready for the stress test and be a winning position risk and stops wise. Even if all your positions at that point are stopped out you want to ensure that you will be making a higher low on your equity curve. In years 1-7 you should focus on interpretation of the cycle while in years 7+ you can look to anticipate.

Continuation Stress Tests

The stress tests patterns will continue days 8-11 , 13-15… Be ready for them and ensure that position wise you are in a winning position. The action of your own portfolio is the best gauge of the market strength and whether you own the leaders.

Trading Later in the Cycle

In trending environments when the market is for the most part above a rising 50 and 200 SMA, the typical upcycle lasts 20-25 days. Down cycles will be shorter lasting only 2-5 days.

However, in negative markets such as we have seen in 2022, down cycles can last much longer and it is the up cycles that are limited.

It’s important to be aware of the larger context conditions as well as when we are later in a typical cycle.

Once we have already experienced a few stress tests, you want to be much less aggressive with new buys and you should size smaller. This is because there is less runway for new buys within the current cycle. The risk/reward is not as good so you should adjust accordingly. You can think about this in the same way as not wanting to add too heavy a position far from the proper pivot point. Keep your portfolio cost basis low and size smaller later in the trend.

Stocks that are just now breaking out multiple weeks into a cycle are laggards and are more failure prone. Stick with the leaders and remember that the goal is to have enough of a profit cushion that the moving average rises above your cost basis. When this is the case you can let the trend work for you and let the stock fluctuate naturally. In strong cycles this allows your swing trades to transition into position trades to maximize profit.

Position Sizing and Progressive Exposure

A common question that we are asked is how large should my initial position be that starts the progressive exposure chain?

The simple answer is that it depends on your skill level, experience, and belief in the BP system. Ray looks to anticipate the BP reclaim with as much as a 12.5% position shorting the SQQQ and then on the reclaim increasing that up to a 25% position. However, this exposure level is something he has gotten accustomed to overtime after trading the system for years.

If you are just getting used to it, start with a 5% position and work your way up. Avoid large jumps in exposure as that may increase emotions that can derail proper approaches.

Below you can find examples from this year of how Ray used the system with progreessive exposure to take advantage of a cycle

Private Access Portfolio Update

Weaknesses in the System

As mentioned previously, it’s important to realize that nothing works 100% of the time in the markets and every system has its weaknesses.

For the BP system, you should be aware that during strong uptrends there are often false breaks below the BP which recover shortly thereafter. We are currently in the process of logic adaptations to improve in this area.

In addition, during options expiration, the BP may provide false signals due to the restructuring of the markets. Be cognizant of this fact as Ray usually treads lightly during these weeks.

Since the summer of 2021, we have been tracking the cycles in a spreadsheet which you can use to study the system.

Market Cycle Timeline

Key Takeaways

Correctly identifying the current market cycle is one of the most important aspects of trading. Remember that human behavior and psychology are at the core of everything and translate into patterns and the market cycle. 

The goal is to get from a state of interpretation to anticipation. The BP system provides a structure to do just that and a framework where both swing and position traders can be confident when a new rally is starting.

We’ll diving into even more detail in the Market Cycle Mini Course so stay on the lookout for that!

Questions? Let us know if you have any questions in the comments below.

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