Overview
Trading market cycles means using an understaning of the business cycles in an economy and their impact on assets to optimally choose an asset mix.
Four Primary Markets
There are four primary markets that form the core of macro trading strategies.
Market Cycles
Global macro strategies often rely on the cyclical nature of markets to drive their allocation strategy. Market cycles are driven by the economic phenomenon of business cycles. That is, macro economies have been observed to go through periodic cycles of boom and bust.
At the beginning of the cycle, interest rates begin to decline. (that is, bond prices move up) This is due to a cooling off from the previous cycle, and the central bank often lowering rates to encourage growth. Soon, the decling rates begin to ripple through the economy which causes demand to go and businesses start to produce more. The increased activity starts to push equities higher. As demand continues to grow, commodity prices begin to be pressured from increased demand, which causes commodity prices to increase.
Once the market begins to overheat, the central bank begins to raise rates, which causes bond prices to turn down. Eventually, equity traders begin to discount a downturn and equity prices begin to turn. Commodity prices remain high as demand remains high. Once the increased interest rates ripple through the economy, demand finally begins to lag which causes commodity prices to decrease.
The description of market cycles presented paints a picture of three markets. Bond prices lead, followed by equity prices, and lastly followed by commodity prices.
(see Pring chap 2)
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Note: the above chart should not be interpreted to mean that market cycles are fixed in length. In fact, the challenge of identifying market cycles typically is identifying the length.
Forecasting Cycles
The challenge for utilizing market cycles is that the cycle needs to anticipated in order to utilize it for trading. That is, market cycles are not the same length each time, in fact, there is great variability in market cycles.
The following are common ways to try to forecast market cycles.
- Leading Indicators - leading indicators are indicators that are thought to anticipate trends in the economy. Perhaps the challenge to using leading indicators is being to identify which indicators are the leading indicators, and in particular, finding effective indicators that the market generally doesn't follow.
- Central Bank Speculation - the central bank is a key player in the economy, and often are the catalyst for changing market conditions. It is a key strategy of macro traders to evaluate current economic conditions, and to forecast how the central bank will react to those conditions. Traders with greater insight and better central bank forecasts are often the best macro traders.