Cyclical analysis is a top-down approach Harley advises.  Identify the longest dominant cycle, then work down to the smallest cycle affecting price activity.  Most cycles have subcycles embedded within them, usually two or three, which Harley refers to as the alpha, bravo, and charlie components.  When a particular cycle is nearing its trough, it will tend to dominate the shorter cycles which comprise it, causing them to contract or expand beyond their usual frequency schedule.

Harley defines three essential elements required in cyclical analysis.  The first element requires an awareness of the numerology underlying the derivation in market cycles.  Most market cycles have their roots grounded in fibonacci numerology Harley has found.  The second element requires that the analyst employ statistical analysis to verify the numerology premise and provide mathematical organization (computation of the central tendency and its variation) to the data under study.  The third element involves the development of properly designed tracking tools that can measure the cyclical function under study and recognize its turn in as close to real time as possible.

Long-term readers of The Harley Market Letter are aware that in performing cyclical analysis of the financial markets, it will often be found that the time period taken for one complete cyclical rhythm will vary from beat to beat.  To ascertain the central tendency of the data, Harley performs a statistical analysis of the data.  From this analysis, he uses both the mean and the median of the data to project the window of time for the next reversal point.  Experience has taught him that even though a cycle has had a history of market lows, it may not necessarily produce another low at the next occurrence.  One has to be ready for a low or a high to occur.  However, it is little more than academic to know that a cycle has occurred in the past – as a trader, investor, and newsletter author, it is critical to know that a cycle high or low is occurring in the present – necessitating the need for mathematical tools than can track a cycle in real time.  One of the tools Harley employs involves the calculation of the rate of change in price – the slope at which a stock or commodity moves up or down.   So called “market momentum” is really no momentum at all, for those with a background in physics or engineering will recognize that any measurement of price over time is correctly called price velocity.  For a price velocity indicator to be valid, it must be based on cycle length.  If it is, the indicator will correctly measure the rate of change of prices with a cycle and turn up or down as the cycle itself turns up or down. 

The other calculation the analyst should perform involves determining trend through measurement of price range.  Any range-based measurement – stochastic, percentage range, or relative strength indicator – will do.  The important point is to employ the calculations over multiple time periods (no less than three).  A trade-execution signal will be generated when both sets of indicators – price velocity and price range – turn together in the desired trading direction.

Cyclical turns can be reflected in a number of ways.  Sometimes they mark the exact low or high of the move.  Sometimes they mark a retest point.  At other times they are marked by the apex of a sideways pattern that results in an expansion to the upside or to the downside.  It’s not always possible to know in advance which of the aforementioned will define the cyclical structure until after the fact.  One form or a multiplicity of forms may occur.  Harley defines the cyclical turn as the point at which price velocity balloons in the direction opposite of the trend that preceded it.  In a bottoming evolution, for example, the time point that immediately precedes the point at which price velocity suddenly expands to the upside is the cycle low point in his definition. 

One final characteristic of cyclical behavior involves the concept of translation.  In bull markets, there is the tendency for the cycle high (crest) to occur to the right of the midpoint of the cycle.  This is known as right translation, with prices rising for a greater amount of time to the high than it takes to decline to its next low, and is characteristic of bull market cyclical structure.  In bear markets, the same cyclical schedule from low-to-low is retained, but there is the tendency for the cycle high to occur to the left of the midpoint of the cycle.  This is known as left translation, with prices rising for a shorter amount of time to the high than it takes to decline to it next low, and is characteristic of bear market cyclical structure.

Knowing when to buy and when to sell is the cardinal axiom for successful investing.  The knowledge and exploitation of market cycles embodies one of the most powerful analytical tools available for identifying trends and forecasting their reversals.   But market cycles do not present the investor with a magical formula that will time a market upturn to the precise moment.  What they do afford, in objective fashion, is a means to quantify the timing of your investment decisions. 

Investing in a bear market presents new challenges for conservative investors. No one wants to loose money. Fortunately, there are safe strategies for conservative investors to continue to invest their money. This conservative investment idea is designed to save your IRA from experiencing losses during a bear market. In addition, it helps to position you for the recovery in the stock market once it begins.

Cash is King

When investing your IRA portfolios during a bear market the best strategy is to stay in cash, use income investments, and/or be short. In a bear market, I divide my IRA portfolio into three segments, not necessarily equal. My objective is to preserve my capital until the market turns around with a secondary objective to make some money.

Invest the first segment in a money market fund. Cash is a position that has no risk and earns a small return. Money market funds are fine for this. They are safe and you can access your cash when you need to do so. The percent of your portfolio that you place in this segment depends on your comfort level with the other two strategies.

Build a Ladder

Use the second segment to capture slightly higher returns from longer-term income investments than what is available through money market funds. You build what is called a ladder. The idea is to invest in longer term securities that are completely safe. You can do this with bank CDs or Treasury bonds. Assume you have allocated $24,000 to this segment. At the beginning of the bear market or when you decide to get out of the market, go to your bank to set up six certificates of deposit (CD) as follows:

• $4,000 in a 1 month CD
• $4,000 in a 2 month CD
• $4,000 in a 3 month CD
• $4,000 in a 4 month CD
• $4,000 in a 5 month CD
• $4,000 in a 6 month CD

As each CD matures, roll it over into a 6-month CD. After six months, you will have six separate 6-month CDs maturing every month. Continue to roll them over as each one matures. You could use one year CDs as well.

When the bear market looks to be over, you can then move the money from each CD as it matures into the market over a six-month or one-year period depending on the maturity of your CDs. This way you can enter the market in stages and you will not commit all your money at once.

You can also use bond mutual funds to accomplish the same idea, if that is what you have available in your IRA.

The concept of building ladders is commonly used in bond investing and in situation where the investor needs access to their money on a regular schedule. You can set up ladders for college savings, retirement payouts, or any other situation where you want to receive your money over a period of time.

Short the Market

In the third segment, hold a portion of your portfolio in and ETF that shorts an index such as the S&P 500. If you can only invest in mutual funds then use one of the inverse mutual funds. The purpose of this segment of your money is to take advantage of the weakness in the market and make some money. You are in a bear market, so being short takes advantage of the downtrend of the market. This segment will experience more volatility during bear market rallies. The level of volatility you can stand will help determine how much money you commit to shorting.

This strategy works for portfolios where you are somewhat limited in where you can place your money such as IRAs. It is conservative in that it stays primarily in very safe investments and the securities you buy are with the overall trend in the market.

Transition Bull to Bear and Bear to Bull

The decision whether we are entering bear market can be made easier, if you stage the building of your bear market portfolio over a couple of months. For example, if you believe we are about to enter a bear market, you can close out most or all of your long positions and move to cash. This might take place over the course of several months. For more on how to identify a bear market, please see xxx article.

If all indications still point to a bear market, then start to build your ladder using either CDs or bonds. Then start an initial investment in a mutual fund or ETF that shorts the market such as the S&P 500. During the course of a bear market, there will be rallies that last from a couple of weeks to a couple of months. If you can, try to buy more shares of a short fund at the top of one of these bear market rallies and then sell some of the shares at the next low point. Do not want to sell all my shares, since the overall market trend is down and you want a downward bias to this portion of your portfolio. Your goal is to take advantage of the volatility of the market.

This buying and selling of short mutual funds is what changes the dollar size of your cash position. A keep some money in cash just to be conservative. The amount you invest in a short position depends on how much risk you wish to take with your retirement funds. To me it is prudent to risk no more than 50% in a short position. However, that depends on your own financial situation and your ability to sleep at night.

The transition from a bear market to a bull market tends to follow the reverse course. At the first sign, the bear market is ending; close out the short positions moving to cash. Have a set of stocks and ETFs that you want to be ready to buy should the new bull market be real. Start to establish positions in the best stocks and funds that should do well in the early stages of a bull market. As long as the signs of a bull market remain, move more cash into these early positions over the course of a several of months. Start to draw down the ladders, adding the cash to long positions until fully invested.

The objective of this transition process is to capture the vast majority of the trend, yet not commit all your money at once. It gives you some flexibility to adjust your strategy incase something unforeseen takes place.

The Bottom Line

Conservative investors can overcome the affects of a bear market by using simple strategies to allocate their IRA portfolios in safe investments. By employing, the techniques mentioned you could save your IRA portfolio from a meltdown. After all, the first rule of Warren Buffett’s investing strategy is to not loose any money. It is a rule well worth following.

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