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How to Take Advantage of Stock Market Cycles

Breakout

With an endless stream of economic data, earnings results, analyst reports, and technical trends to follow, it's easy to see why so many investors are at a loss to figure out where the market is going at any given time.

But beyond all of those numbers and readings, there exists a bevy of time-tested events and occurrences which have proven to possess a profound influence over the markets.

In this installment of Investing 101, we dive into the elusive science of "market cycles," a trading phenomena that Jeffrey Hirsch, author of The Little Book of Stock Market Cycles describes as "regularly occurring, has a reason to repeat, and is driven by a real event."

War and Peace

While investors track dozens and dozens of different cycles, Hirsch says none is more influential than the effects of war and peace. "Once peace prevails and the troops come home and the bills come due, inflation rises up," Hirsch says in the attached video. He adds that, "Once that inflation levels off, you see the market catch up with that inflation; you see that sort of 45-degree angle, big super bull market, those 500% booms."

The Presidential Election Cycle

Another prominent (and timely) cycle worth studying right now, Hirsch says, is the activity that happens during Presidential Elections. As we recently discussed, strong stock market performance in the three months leading up to the election have historically seen the incumbent (or his party) returned to the White House. However, Hirsch points out that the real bang for your ballot box buck has already gone by.

"Typically the third year is the best, as the President begins to prime the pump," he says, pointing out that this cycle "hasn't had a loss since 1939 when Germany invaded Poland." Drilling down further, Hirsch says "the sweet spot" for this quadrennial theme "is from the fourth quarter of the mid-term year to the first quarter of the pre-election year," racking up an average gain of 15%.

Seasonal Indicators

You may have heard Wall Street pundits use the phrase "Sell in May and go away" in reference to the market's historical tendency to drift through the summer months. It's so widely mentioned, that it sounds like a cliche. But Hirsch says, the most important part of this expression is usually ignored.

"The part that people often forget is the buying in October or September," he says, referencing another cycle he advocates to capture the "seasonal boom" often seen during the six-month period from November to April. Fittingly, he calls this the "best six months switching strategy.''

One of Hirsch's annual duties in his role as Editor-in-Chief of the Stock Trader's Almanac is to remind investors each New Year of the importance of the first month's performance by way of the January Barometer --arguably the mother of all market cycle indicators with nearly 90% predictive accuracy over a 60-year period. So goes January, so goes the market.

"Things happen in January. You have Presidential innaugurati0ns, State of the Union addresses, a new Congress, company forecasts, anticipation of fourth-quarter earnings," Hirsch says, explaining that if things are great in January it gives you a good idea that they going to be good for the rest of the year.

Weekly and Daily Cycles

Market trends can even be found in weekly and daily cycles. Hirsch tracks a number of shorter-term indicators, including the opening and closing hours of the stock market, from 9:30am to 4:00pm est.

Hirsch says "from the 3 o'clock hour to the close you see this rally, almost on a regular basis." And according to his data, don't buy stocks at the open. According to his data, the Dow Jones Industrial Average has lost a combined 44.3% in the first 30-minutes of trading from 1987 through mid-2012.

As for weekly trends, Hirsch says to watch how the market moves on Mondays and Fridays. If both days show a trend of weakness, it's a strong indicator that "the market is in trouble."

While there is almost no limit to the number of ways that Wall Street will try to discern the direction of the market, be it from the length of women's skirts to the winner of the Super Bowl, Hirsch and other investment pros use these cycles as a guide in conjunction with other data, before making any major decisions.