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RichardCox

Hurst Cycle Analysis

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Hurst Cycle Analysis

 

An American aerospace engineer, J.M Hurst was one of the first people to use computer technology to plot and analyze the cyclical behaviors that can be found in the financial markets. This occurred as early as the 1960s, and shortly after he published The Profit Magic of Stock Transaction Timing, where the introduced the theories that would eventually form the basis for what we now call the Hurst Cycle.

 

Hurst’s approach to the market rests on the idea that multiple cycles act in concert as price and time moves forward in the financial markets. Hurt’s explanations stopped short of what actually cause these cycles, but he still believed these occurrences could be understood in ways that would allow traders to profit from them. Hurst’s studies included more than 1,000 different asset types, as he sought to understand the nature of price changes rather than to attempt cornering any single market.

 

Summary of Concepts

 

The mathematics behind Hurst’s approach can be difficult to understand, but the main points can be summarized here:

 

● The financial markets behave in a cyclical fashion.

● There is a set of number recurring cycles that range from short to long time intervals. This cyclical set is referred to as the Nominal Model (shown in the first table below).

● Market cycles are harmonic, and relate with other by factors of two or three

● Cycles build on each other, creating larger composite cycles. This is also referred to as the principle of Summation.

● Longer cycles generate larger changes in price. Hurst referred to this as the principle of Proportionality.

● Lows for the cycle unfold quickly when short composite cycles create troughs in the same region. This is also referred to as Synchronicity.

● Cyclical peaks will often appear rounded, whereas troughs are usually sharper.

● Variations in cycle length will occur, but market cycles always revert back to their averages.

 

Harmonic Ratios and Cycle Periods

 

One of Hurst’s central discoveries was that market cycles are not random in terms of periodic wavelength. Instead, the prominent wavelengths are related by a harmonic ratio (factors of two or three). According to Hurst, these wavelengths are recurring and can be applied to all markets. These wavelengths can be divided in terms of time and can be found in the table below:

 

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The time periods stretch from 5 days to 18 years. In the table above, we can see that there is the potential for variation within each wavelength. But these variations will be minimal and will always revert back to their averages. Hurst also found that the market’s dominant cycles will have synchronized troughs but not synchronized peaks. This is a critical element of the Hurst cycle analysis as it allows traders to project the size of the wavelengths that will follow.

 

Ultimately, the underlying trend can be defined as the motive effect of the longer term cycle, relative to the shorter term cycle you are trading. Trading in the direction of the broader cycle can help to improve positioning probabilities.

 

Analyzing Sentiment

 

The central idea behind Hurst’s cycles is that nature tends to move in a predictable rhythm. For example, night and day changes at the same rate, and the seasons follow one another in a fashion that can be anticipated. These expectations can be applied to the financial markets, as well. Optimism and pessimism unfold in cyclical ways, first tentatively and then with greater force as more of the market starts to accept the changing reality. These trends (price movements) then reach a point of exhaustion, traders realize that prices have deviated too far from their historical average, and then the trend starts to reverse.

 

This, of course, is a simplified view of market activity. But most sentiment behavior follows along these lines and, as a result, should not be viewed as random. In any given moment, there can be a variety of sentiment cycles acting at once. Short term trends might be bearish while medium or long term trends are bullish. Everything comes down to the current cycle and the peripheral cycle that most directly influences it.

 

Hurst Cycles Peaks, Troughs, and Wavelengths

 

In some cases, price cycles will be clear and obvious. In other cases, they won’t. To some, this might suggest that trading with cycles is unreliable. But when the right tools are applied, these types of strategies can start to show much better results. The black line in the chart graphic below shows a cycle starts by falling to a trough at point A. The cycle then turns positive through point B and rises to a peak at point C. A similar movement follows, only in reverse -- falling back through point D and than to another trough at point E. As a point of illustration, let’s assume that points A and E represent the same price level.

 

jjl30w.png

 

In this case, the distance between points A and E would represent the length (or time period) of the cycle. We can also see the distance from the peak to the trough as the cyclical amplitude. The longer the wavelength, the more power present in the cycle. For example, a one-month cycle will generate larger price moves then a one-week cycle. In the chart example below, we can see how Hurst cycles might look on a bullish swing move:

 

2dl9aw1.png

 

Hurst’s “Valid” Trend Lines

 

Trend lines can be a great tool because of the way they allow traders to bring visual order to the underlying price activity. But Hurst argued that most trend lines are subjective, and that we should instead view price action as a composite of cycles (of differing magnitude). All cycles (shortest to longest) form the composite and define the net effect of the trend (positive or negative). For example, if the Hurst cycles are advancing together, then the long term trend is bullish. This would ultimately meant that the short term Hurst cycles would produce troughs that are successively higher.

 

dy0llj.png

 

The chart graphic above shows a cycle with an underlying trend that is essentially flat. If we were to draw a line connecting the adjacent lows into the future, the result would be horizontal. This line could also be viewed as a support line, as it would attract most of the price activity. But if the longer term cycle is pointed upward, the same action of connecting the troughs would result in an upward trend line where bullish positions could be taken. Hurst argues that these trend lines are objective (i.e. “valid”) because they are based on a clear rule -- connecting the cyclical troughs. These Valid Trend Lines (or VTLs) can also be used in reverse. Any time these formations are broken, it is a signal that the longer trend cycle has reached its conclusion. This information is useful because it gives us an objective trend reading and better insights into the magnitude of the potential reversal.

 

The Future Line of Demarcation (FLD)

 

In conjunction, Hurst also introduced his Future Line of Demarcation, or FLD. Conceptually, the FLD is a bit more complicated. But it is essentially the original Hurst cycle displaced, one-half of the cycle’s period to the right. In the chart below, the FLD is shown as the faint black line. The darker blue line is the Hurst cycle:

 

2zta53m.png

 

As you can see, the FLD is simply a copy of the cycle, moved to the right by half the cycle wavelength. If you cycle is 180 days, you would plot the FLD 90 days to the right.

 

The FLD tells us three things:

 

● Confirmation of a previous peak or trough

● An indication of future price direction

● The magnitude of the following move

 

In the chart below, these three points are outlined:

 

217j2x.png

 

Here, we can see that when the FLD crosses below the Hurst cycle (green circle), the peak of the cycle is confirmed. When the FLD crosses above the Hurst cycle (green circle), the trough of the cycle is confirmed. The following price movement will continue in the direction of the crossover (purple arrows), and the magnitude of the movement that followed will be equal to that of the previous cycle (measured here using the orange line). All of these factors tell us when a Hurst cycle is changing, how far prices are likely to move, and in which direction they are likely to travel. A good way of interpreting the FLD is to assume that the Hurst cycle will peak as the FLD makes a trough, and vice versa.

 

Conclusion: Hurst Cycles Help Define the Predictable Nature of Market Sentiment

 

Hurst’s work might seem complicated at first. But when we look at the underlying reasoning, it merely attempts to describe the predictable nature of market sentiment. There are a variety of platform tools that can be used to express these changes, and most of these tools are best used when traders are looking to define the probabilities for trend continuation or reversal.

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Hurst concepts always interesting. Too bad the semantics and verbiage will drive the average trader away instead of pulling them towards understanding the concepts.

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Hurst concepts always interesting. Too bad the semantics and verbiage will drive the average trader away instead of pulling them towards understanding the concepts.

 

I agree. The same with Gann's works and much of really good Elliott's.

 

Just saying.

 

TW

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