Forex Trading System- Bear Cycles

OVERVIEW

The current study is identical to the study of bull cycles in the previous chapter except,of course, the trend is moving downward. The terminology and the testing approach arealso the same as in the previous chapter.

IDEAL BEAR CYCLE

The ideal bear cycle is the arithmetic inverse complement to the ideal bull cycle.
This cycle consists of five waves, three downward and two upward. The downward waves in a bear cycle are called impulse wavesand the upward waves are called corrective waves. The ideal bear cycle has the following mathematical constraints given that
the letters “a” through “f” represent prices.

First, the length of each corrective wave must be less than the length of its preced-
ing impulse wave:

c – b < a – b
e – d < c – d

Second, no peak in a five-wave bear cycle may advance above any preceding valley:
e < b

OBJECTIVE

Our goal is this study is to determine if the same levels of retracement occur in bear cycles that occur in bull cycles and how closely they align.

INITIAL RESULTS

The column headers in Table 29.1 are defined as:

Rev Amt is the reversal amount, the number of boxes required to trigger a reversal
in price direction.

Swings is the number of waves in the swing data or the sum of the peaks and val-
leys less 1. As the reversal amount increases, the number of peaks and valleys de-
creases due to the filtering process.

Matches defines the number of occurrences where the test pattern (the ideal bear
cycle) matches a sequence in the swing data.

Ratio is the average ratio between the height of all five waves in the bear cycle di-
vided by the height of the first three waves in the bear cycle.

Retraceis the average retracement of the three-wave bull cycle in relation to the
five-wave bear cycle;

PRAXIS

A practical example follows. (See Figure 29.2.)
Given that the price formation has already occurred with the following prices:
a
1.0018
b
1.0008
c
1.0013
d
1.0003
e
1.0006


we can now estimate the market entry point “f” for a long trade to trap the length of the following three-wave bull cycle by first computing the height of the first three waves “a” to “d” in the bear cycle:
Length = a – d
.0015 = 1.0018 – 1.0003

Next we must project the price of f, the height of the fifth and final wave in the bear
cycle:
f = a – 1.205 (a – d)
1.0000 = 1.0018 – 0.0018

To calculate the objective price (the market exit price), we multiply the average
retracement percentage (39.9 percent) times the height of the five waves in the bear
cycle:

Height = a – f
= 0.0018
Exit price = f + (Percent Height)
= 1.0000 + (0.399 0.0018)
= 1.0000 + 0.00072
= 1.0007

Ideally, the trade will occur as shown in Figure 29.3, with the following projected
prices:
f
1.0000
g
1.0005
h
1.0002
i
1.0007

In this example and the analogous example in the previous chapter, we used a
three-pip box size to create the swing data and forecast a return of seven pips.

Using this system, the projected profit will always be at least the size of the reversal amount times the box size. In this case, it was 2.3333 times the minimum swing threshold.

CAVEAT

As usual, any new trading mechanism has to be thoroughly tested via paper trading be-
fore incorporating it into one’s overall trading system. One drawback in the bear cycle trading mechanism is that the standard deviation of the average retracement percentage was slightly high at 4.9 percent. This means that there is a 68 percent likelihood that the exit price will fall between 35.0 percent and 44.8 percent retracement of the height of the bull cycle (39.9 – 4.9 and .39.9 + 4.9).