Behavioral finance FAQ / Glossary (Cycle / Cycle-trend)
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Cycle / Cycle-trend
08/2i + See trend, bubble, extreme,
bandwagon, momentum, overreaction
Up and down, up and down.
Enjoy the market ride!
Swinging from pheasant with truffles
To chicken wings with ketchup.
Business cycles, as well as asset market cycles, are
alternating phases of rises (expansion) and falls
(contraction) in volumes, prices and returns.
Cycles and trends
Markets are lands of hills and canyons
Be well equipped to cross it!
Economic growth as well as financial market evolutions are rarely linear (see nonlinear).
The economic / financial fluctuations can be
* minor vibrations,
* sometimes sudden hiccups or jumps.
* and even rather long periods of fat cows and others
of skinny bovines, as prolonged rising or falling phases.
=> Let us focus on those long upside or downside periods
Those long waves are usually called trends (see that word).
They last at least several months, and typically several years (*).
(*) Even several decades, when talking about "long cycles / long trends",
which might be linked to deep historical technological upheavals,
social evolutions and economic paradigms
and which include several shorter cycles).
After a while, at least as concern financial markets, a trend gets often out of hand
and leads to excessively low or high prices (see extreme), until it reverts
to the opposite trend, let us swing, baby !
What is fattening or starving the financial bovines?
There are many reasons for those important,
and sometimes extreme, swings:
From "hard" factors (unbalances) such as
Natural and human resources availability,
Monetary and industrial / commercial phenomena (detailed below)
To "soft" ones (economic player behaviors)
such as alternating borrowing / spending / investing
behaviors, that mirror attitudes and expectations that
vary from exuberant hope to excessive fear.
A matter of time
Cycles are not full disruptions that instantly adjust prices.
The investors' optimism (the "parachute of hope")
or pessimism (the "wall of worry") takes time
to disappear, to fall from 80% to 20 % of the population.
This long delay is needed to heat, overheat and block the engine, and for a trend
to start, to develop, to reach extremes and...to cease, for the next trend to start.
This is the under-reaction / adjustment / overreaction chain (see those words)
Statisticians have noted that an asset or market that has shown an impressive
rise or fall in a previous year has a high chance to do the same in the following
year (see momentum effect, bandwagon effect).
It often leads after a while to a growing discrepancy between prices and
"fundamental values", with a violent correction and trend inversion after
This is the glory and danger of momentum trading / trend following
(see those phrases).
You can gain a lot when riding the bandwagon and lose even more when it reverts
Even violent crashes:
* Not only tend to come late, as the imbalances (for example a general
and / or overpricing) take time to be accepted,
* But also they do not "purge" fully and immediately the market mispricing.
Actually the "corrective" new trends persist often until the mispricing goes to
the other extreme (see under- / overreaction).
Cycles vs. randomness and volatility
Market moves do not seem to be due only to the dice,
as dice stick to randomness and ignore market sector rotation.
Those alternations are more than simple random accidents
and cannot be fully explained by the "random walk hypothesis" (see that phrase).
What contradicts randomness is:
The persistence of those upwards or downwards trends,
as they can last for months or years.
Their repetition: after one up-and-down cycle, another starts
The wheel revolves on and on, although irregularly.
In asset markets, those traits make them sometimes called
cycle- trends or momentum cycles.
Some see cycles affecting asset market prices, as
"medium / long term volatility",
with just a difference of scale between short and medium / long variations.
This is seen not only in market price evolutions but also, more generally,
in many dynamical system that fit fractal charts.
However irregular are their amplitude and duration,
no problem to use the "cycle" word.
But determinist mathematical functions should not be pushed too far
to describe phenomena in which human behaviors play a part.
Can those fluctuations really be called "cycles"?
Markets do not seem to exactly ride the clock needles either.
Whatever the mystique.
Although commonly used, the "cycle" word is rather a misnomer.
To label those phenomena as cycles would mean a perfect clock-driven (*) (**) regularity
of occurrences, amplitude and timing.
It is not the case, as those economic or financial "fluctuations" or "alternations"
are most of the time rather irregular (although not completely erratic)
Their magnitude, length and shape never repeat exactly ,
nothing like the seasons of Earth orbiting around the Sun
There are also asymmetries of lengths and sizes between
rises and falls: often the rise lasts longer than the fall, although the contrary
can happen also.
=> Thus, some prefer to call them aperiodic cycles or near-cycles.
Markets have irregular heartbeats.
(*) Beware of some mystical approaches that see universal mechanical regular rhythms
behind market cycles in particular and social events in general.
Everything goes in investment theories, including mysticism (see that word).
Some see repetitive waves that would be related to golden numbers and universal
They brought their own esoteric / numerological / cosmological visions (Elliott,
Gann...), sometimes under a label bringing a scientific aura (socioeconomics...).
(**) Some see here an intermingling of different cycles, which complement or oppose
each others in amplitudes and lengths, and have their own subcycles.
On a chart, the whole agitation would show multi-fractals (see fractal).
What causes asset market cycles?
What fattens or starves the financial cows?
The state of the economy? Or the investors' mood?
No asset market cycle is exactly identical to another.
Even the word "cycle" is not fully relevant as seen above.
The causes of "cycles" could be sorted in two kinds,
1) Fundamental factors (economic unbalances):
Money supply and interest rates variations,
Mismatches between production and consumption (and resource
Technology changes, competitiveness problems or gains, etc.
Those economic phenomena are:
"Mechanical" - or, a better metaphor, "hydraulic"
as showing some similarities with problems of underflows and overflows
in a bathtub.
Some might even see just a general statistical law of
"regression to the mean"
But also caused by behavioral factors affecting the economic players:
producer and consumer expectations, sentiment and behaviors...
2) Alternations of extreme collective investor expectations
Those factors are financial market traits, not always related to economic
See "bubble and crash", "herding", "greed and fear",
and many other articles in this glossary.
In some cases only one of those kinds of causes is at play,
in other cases they coexist or follow each other, showing some cross-influence.
A typical case: stock market cycles
Slow dancing with some partners, fast swinging with others.
Stock markets are typical places to see such irregular alternations of bull and bear trends / waves.
Also, they imbricate irregular sub-cycles of different lengths.
Here are some asset / stock market cycle traits:
The stock market history shows a combination of short and long
They last several days, months, years, decades or even generations
Also fractal theorists see here - maybe a bit too systematically - an intermingling of
several long cycles, and of all their sub-cycles (multifractals)
Cycles might differ between asset classes, sectors or even individual
Every asset sector, and as concerns the stock market each industry or stock type,
catches the investors' attention in its turn, in a kind of market rotation (see rotation).
This either reflects fundamental motives or occurs because investors follow fashions.
What is affected:
Those alternations concern as well prices and returns as
The volatility range usually gets broader in periods of strong uncertainty, often
linked to bear markets; and it recedes and stabilizes later (see heteroskedasticity).
How far-reaching is the cycle phenomenon?
Financial market pulse? Or general economic and social beat?
Cycles-trends causes and effects:
Are sometimes limited to the financial sphere.
At other times, are correlated to larger socio-economic unbalances
The correlation in timing and amplitude between those two kinds of fluctuations, the financial ones
and the economic ones, seems to be loose (lead-lag effect: see hysteresis), and in some cases
non-existent (complete disconnection).
Another thing is that financial cycles are about prices while prices in business cycles are only
one variable among others (i.e. volumes of production and consumption).
financial cycles tend to repeat more often than business cycles.
This makes it difficult to consider them as predictive signals
to anticipate economic evolutions.
We can see cycles in many social fields , for example in "public choice" (see that
phrase), or in garment fashions.
A well-known one in politics is the "majority cycle" (the "voter's pendulum").
Cyclical analysis / cycle-trend analysis
Avoiding misinterpretations that might make you red-faced
and might shrink your purse.
However irregular cycles are, they have to be detected and taken into account
in order to separate short term economic fluctuations from long term evolutions.
It is therefore necessary to use long enough time series when analyzing economic growth
for example so that not to be misled by the "law of small numbers" (see that phrase).
Cycle-trend have also to be accounted for to assess stock market levels.
The level of P/Es (Price-earnings ratios) might be misleading due to
A high P/E might mean two different things:
Either the stock is overpriced,
Or earnings are momentarily very low because the company (or the sector, or
the whole economy) is in the low point of its business cycle
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