Small-cap stocks market cycles
The majority of global markets move in cycles, and small-cap stocks are not an exception. Try not to think of cycles as single trends, but rather think of them like a soup, the mixture of many elements that dictate the flows and temperature, weather hot or cold. The activity on social media and traditional media, objectivity of financial channels, the optimism among beginner investors, the speed of market moves, all of those variables contribute to defining the cycles.
Many variables contribute to the shaping of the cycle, and it is impossible to define the cycle itself just by using a single variable. Remember to consider the cycles like a mixture of ingredients that all form a soup. If a trader tries to define a cycle just by using the single indicator (such as moving average), he/she will likely fail getting faked into shifts that have no real follow-through. And keep in mind that the longer and the more variables that eventually align into the same direction after a prolonged time (few weeks/months), the more likely it is that cycle might be ending soon. When everything points to a strong bull cycle for extended period of time, often that will be a top. Critical being - present for extended time.
Cycles when they are apparent early to experienced traders will tend to be much more mixed in expression or dull to the beginner market observer. This is because each cycle shift when it is in young stage will be a mixture of bullish and bearish signals and variables (as older previous cycle leaves lagging variables present). When things get too obvious and one sided, with everything aligning to a specific bullish or bearish cycle, that is usually the tip of the iceberg, and reversal will follow soon after. How soon is debatable, and it differentiates for each market. When it comes to small caps, cycles can shift quickly, and by that, I mean within a day or two. Something that is not common to most other markets since cycles there tend to be like a slow-moving tanker ship.
Keep a critical factor in mind, and this applies to any market, not just small caps: Bullish cycles (especially very hyped ones) tend to reverse much quicker than the bearish cycles. It takes a lot of buying power and the slow grind of media attention for a bearish market to turn into bullish. Bearish cycles rarely shift from cold to hot phase "overnight" with a bang, meanwhile, it is not unusual for bullish cycles to enter the cold phase and crash strong within a very short period of time. This behavior has to always be present in traders' minds as being adaptive and careful on cutting losses if long under a strong bullish cycle is more important than being so under bearish cycles. Under bearish cycles, usually, a trader has more time to adapt to shift, the room for mistake is wider. Traders longing at late stages of the bull cycle have the smallest room for mistakes and usually, those lead to bagholding very often if tight risk management is not used, since less experienced traders tend to often get shocked by how quickly the strong cycle can shift into bearish. And generally one learns those lessons only through live experience, no historical study can prepare you well for it.
Traders' responsibility is to recognize the cycles as there are few distinct advantages of trading with the cycle versus trading against it, or being oblivious to the presence of cycles and just trading the market neutrally. Most traders realize the cycles exist in each market, but they fail to recognize the shifts or how to adjust trading methods to each cycle differently.
When trading with cycle direction (for example, long trading in the bullish cycle), the trader is likely to have a better win rate, fewer stop-outs, and overall higher RR on trades.
If trading against the cycle and its flows, the opposite might be true, and it often is. However, this does not apply to every market the same, and it depends on where the market is tilting over a long period of time (5 years). Meaning, if the trader is shorting SPY/SP500 without knowing how cycles work, the market will be very unforgiving to him/she, and he/she will get stopped out very frequently. Meanwhile, in small caps, the market will be more forgiving towards short-biased traders because many small-cap stocks are more leaning towards the downside over a large macro time frame. This means it will depend a lot on the market and traders' trading direction, specifically on how forgiving the market might be to traders' willing ignorance or just unwillingness to adapt.
Let's first clear up two major differences. Trading with trend does not equal trading with cycle. Trend and cycle are two completely different things. A trend can have a bullish or bearish direction within any cycle, and the trend itself is more of a behavior that belongs hierarchically under the cycle. Meanwhile, the cycle relates more to the overall state of the flows, the positive or negative hysteria around the market in media, the prolonged conditions of positive or negative capital flows that might be present for weeks or months into or out of specific market niche. Trends can typically shift from bullish to bearish on assets within a day, while cycles are meant to be more long-lasting.
Another aspect worth mentioning is the follow-through rate on setups that are aligned with the cycle. If the trader has a specific bullish setup, for example, and such pattern appears in the bullish cycle, there are higher chances that pattern will work out over 100 samples (compared to trading it in the bear cycle). The win rate will be higher.
It is a relatively easy concept to understand, and it makes complete sense, but one would be surprised how many traders do not follow it. There is nothing wrong with having a mean reversion type of trading approach, which might be market cycle neutral. Still, in reality, most traders are not patient enough to put such a neutral-based mean reversion approach into the right use and often get carried with frequent losses when trading against the cycle too early. Using a mean reversion approach against the bullish extended moves in bullish cycle for example (short), and entering too early, will almost certainly increase the stop-out rate, the losses in terms of P/L, and frustration.
Two examples would be:
1. Shorting small-cap stocks, after market open (first 15 min) into small % extension while small caps are early into strong bullish cycle (January 2021 for example).
2. Longing cryptocurrencies into dips in the early stages of bearish cycle (late May 2021 for example).
Both of those methods are proned to issues from the get-go. And in real trading environment, that is where many traders get the most issues and largest losses back to back, trading aggressively against the actual cycle.
In reality, what happens, is that most traders are aware of cycles but unable to recognize the shift early enough and then force the same neutralized approach across all cycles and then wonder what is going on when they hit a stride of 20 consecutive losses in very strong bullish or bearish cycles (regardless of long or short approach).
For short-selling small-cap traders, there will be one or two strong bullish cycles every year that will test your ability to recognize shift in strength of the flows and adjust for your trading approach, otherwise, prepare to face difficulties and draw-down.
For long-biased small-cap traders, there will be one or two strong bearish cycles yearly that will test your ability to recognize them and adjust, otherwise facing difficulties will be guaranteed.
If your trading approach is not adjusted at right time, or if you are unaware of the presence of cycles, you will likely hit difficulties or consecutive losses in such a case.
Follow the themes and tickers daily performance change
Track your data on how many tickers each day fade and how much of them hold gains relatively decent. Track how big (in %) the average gaps are, how many tickers turn into multiday runners. Those are three basic variables that traders should track just to overtime (one year, for example).
The whole cycle shifts start to make more sense, and the trader gets that hindsight lightbulb moment needed to start shaping up a more detailed cycle tracking approach. The idea is to start noticing the themes, in strong cycles the data will start to line up strongly to the specific direction, while the inverse will be true for weak cycle.
The conceptual image below shows basic cyclical shifts between stages (micro cycles). There are plenty of fading tickers present daily versus where there are larger numbers of stronger multiday runners and how a trader should label that data each day to spot when the data starts to lean in a certain direction.
A trader can use memory, but this might only work for more experienced traders; for beginner traders, it is certainly more valuable and accurate to track the daily data step by step.
There will be a further explanation on article below on how to use fading tickers or multiday runners if they cluster at larger numbers as indication for potential cycle shifts, or just to keep the pulse of temperature on current cycle.
The speed of adaptivity towards new potential cycle
The idea being that if one builds strong bullish bias and is too exposed on many of such tickers under bullish cycle late, once the temperature flips, it is that much more important to recognize it, as without it and still adding to longs can lead to drastic drawdowns. The more exposure that trader has intraday or swings to the same theme or being late into cycle, the more one should pay attention to temperature. One could be tracking media, Youtube, build some simple indicators for price moves detection, or similar methods to have a good pulse on the theme, or do it from experience and having a good pulse on the cycle or micro cycles.
The speed at which the trader adapts to new micro or full-cycle will play a major role. The faster the better, the image below highlights the ideal case, and the realistic case at which the majority of traders or investors will actually adapt or recognize the cycle, and how that lag effect might pose a large issue.
Media "hype vs desert" as potential cycle shift indication
Following the pulse on the recent theme or just the strength of flows can save traders from stubbornly following the previous theme or cycle's previous directional bias.
Many factors contribute to the strength of the overall cycles and their timing on where they are about to end, the media hype being one of those.
It might be the cliche to the point that out, when main-stream or social media activity and mentioning starts to increase at rapid pace for a certain market, the top might be in, or the inverse when there is a prolonged time of not mentioning or very low activity, it might signal the bottom of a bear market. As cliche as it sounds, there is a lot of truth behind it.
Media attention extremes can be a good additional cycle shift confirmation, but only when placed within the context of the past 6-12 months. Because what matters is how steep the increase or drop-off in media activity is to signal a change. For a trader to have value as a potential mean reversion signal, it needs to be very obvious and significant at the rate of change over the past 12 months.
A trader can track:
-Youtube video posting activity for smallcap stocks,
-Twitters activity on posts,
-Mainstream media channels mentioning smallcap stocks;
Those are some pulses on relevant media. The numbers have to be in significant cool-off or increase to have a valid contribution to the potential cycle shift.
Personally, over time I have managed to use the "depression" pulse on Twitter to gauge when large portion of small-cap traders are completely discouraged (and complain) due to no activity in market as potential mean reversion signal to new stronger cycle soon, or when the craze of fresh traders influxing on smallcap trading is strong as the potential topping of strong cycles. It works relatively well, but only if one is very selective and applies it only every 3-5 months, no more. This method only provides value for very extreme cycles, which are on average only twice per year.
Ensure that whatever the media source data used is not too smoothed out; else, it will not provide accurate enough info. In simpler words, the waves between the data need to be consistently relatively wide and deep as much as possible. An example of search results on "penny stock trading" where the data is too smoothed out over past 2 years, for the majority of the time, providing only two decent insights. Ideally, whatever the data source used should provide at least 3-5 signals each year for small-caps:
Do not underestimate the correlation impact on tickers when the new cycle starts or deflates.
One of the key reasons why having a pulse on cycles and themes, in general, is so important, especially for small-cap and mid-cap sectors, is that the correlation impact across many assets can be very high. The price moves across many tickers could be completely correlated, and very often, traders or investors are unaware of it. They think that each of those tickers trades within its realm and its reasons while, in reality, in many cases, the flows will be very correlated. Many (or majority) tickers will deflate quickly once the rug is pulled at once late into stronger bullish cycle, and very few tickers will stand out as "resistance" to the general flows, holding up. The typical mistake that beginner investor into small-caps makes, is buying many tickers late into strong cycle, thinking that portfolio is diversified, while that will not be true most likely, as once the cycle turns, majority of those assets will all at once deflate as well.
This is especially important for swing traders. While intraday trader is usually exposed to one ticker at once, it is not uncommon to see swing traders being exposed to many more stocks at once, since their exposure in size is more minor, and often it takes longer time to find decent opportunities. This increases the chance that swing trader will be exposed to the correlation factor more than intraday trader, especially the one who is not aware of it and unaware of the current cycle. Because traders who are fully aware of how much each ticker is correlated to the next, and the hype of the cycle (especially for stronger cycles) will tend to balance out positions better, use smaller size or have position only on two tickers rather than five or ten.
To measure the correlation factor between the small-cap tickers, make sure to use few different methods. Still, perhaps one of the most s straightforward ones is to compare two tickers, when did they start to rally (on what day), how much their 1-hour charts look similar (behavioral similarities), and how many days each of them was either rallying or dropping versus the other one. If all of the three factors are highly similar, the tickers are most likely significantly correlated. In such a case, it is likely that when cycle or theme shifts, they will both respond in same price direction, or in some cases, pretty much behave "eye to eye".
For swing trader it is important to pay attention to those correlated factors highly. For intraday trader as well, but slightly less than swing trader.
It is difficult to adapt quickly to new potential cycle, but usually, price behavior is a good reflection of when the momentum starts to increase or dry off. Especially if tickers that trade under the same theme are very highly correlated in price behavior, it is that much more important to watch the temperature on the theme and overall cycle because it is likely that they will all follow the same direction, perhaps with one or two "black sheeps" standing out but for the majority of it, most follow the general flows. Usually, finding those two black sheep in the forward analysis is difficult. For example that could be said for recent SPAC tickers, where the theme started to heat up in mid-January of 2021. The momentum lasted till the end of February, where it began to cool off. Within the cool-off period, pretty much all tickers retraced back to where rallies began; all of them were at high correlated price moves, some more, some slightly less.
Example of SPAC theme that cooled off and then the majority of tickers faded, regardless of company composition/potential or the overall hype built into the SPAC. The majority of tickers ended with the same result at both time windows, the power of theme and the correlation of each ticker to the same cycle and theme:
This example concludes the points drawn above for how important it is for trader to know the correlation factors in themes or specific cycles.
Ticker DCRB, SPAC:
Ticker GHVI, SPAC:
Ticker CCIV, SPAC:
The term used in the article is, in some cases, theme and, in some cases, cycle. There are some general commonalities between the two, especially for small caps and critical differences. There will be more mention in another article for theme-specific plays since the themes behave differently compared to cycles, but at same time themes are a part of cycles. Think of them as "specialized" trends of very specific macro patterns. At the same time, cycles have more generalized behavior for each bull and bear cycle. Hierarchically cycle is above theme in terms of flows and impact.
Blindspot to recognition of cycles as a newcomer to small caps
My journey in small-cap stocks began as for many traders in a complete blind spot in regards to cycles. While I did come from markets that were under apparent cycle behavior such as cryptocurrencies and none of which was new to me, the mistake made was that on the surface, the small-cap stocks seemed like a sector where the cycles are not present or at least not too exaggerated. The assumption was that tickers just move within their average, typical behavior, leaning to the fading side more or less. Obviously that was a mistake to assume in hindsight, especially if one wants more accuracy, but since it is rarely discussed in smallcaps trading communities at all or in depth, it is no surprise that so many fall for this assumption on "general" or "average" behavior of such stocks.
By doing a quick data grab, the data will confirm that roughly speaking 70% of day 1 small-cap tickers will fade decently from their tops within the first two days. And then, on top of that, there is also tons of oversimplification of such data from traders on all angles, which contributes to leading traders to the wrong conclusion regarding flows in the small-cap sector, or drawing too averaged view, which leads to many troubles.
Additional interesting "confirmation" is that if one looks at Russell's 2000 small-cap index, the index itself will be very deceptive in revealing the cycles within the small-cap sector niche, because many of Russells tickers are not even reacting often to the hot cycle itself. Or when cold cycle is present, many gapping tickers will most likely not be a part of Russell 2000 index, being very small mkt cap companies, which all leads to a disconnect of Russells behavior relative to actual active cycles within small-caps that most traders trade on intraday basis.
Blackswan chatter within the communities is not unusual and is often recognized, but most of the black swans will be recognized only after the fact by the majority of traders; very rarely anyone talks about them forward as potential (with credible performance).
All of which then adds to the fact that traders take the shortcut and treat small caps as this "averaged" sector where stocks rally a bit but sooner than later, they fade, usually within a single day, especially among the short-biased trading communities. This outlook upon the market niche of being so averaged/neutralized on behavior, is what essentially is the root cause of the majority of big blowups or heavy consecutive losses both for long and short traders, because not enough thought is placed in splitting the behavior within months towards specific cycles or themes.
This is a very dislocated perception if one segregates such expectations within specific time chunks of trading. For example, one could very roughly use the above 70-30% ratios if short biased over a one-year-long period, but what happens when such expectations are placed within a randomly selected time frame on a batch of small-cap tickers, within let's say two weeks. This is where it starts to get interesting because that 70-30% expectation (fade vs rally tickers) could become very misleading and incorrect. It happens because traders tend to neglect the fact that this market niche moves within the cycles, just like the majority of markets do (especially smaller markets). It is not the intentional ignorance; in my view from conversations with many of traders are interested in finding how cycles and shifts of flows work in small caps, but because it seems so complicated and deceptive, they go to the easiest common denominator and therefore return to conclusion mentioned above, 70-30 and eventually everything fades, short-sellers primarily of course. Because in noisy data, that is the only rough conclusion that one can make, especially for less-experienced traders. Some conclusion is better than no conclusion at all, if too complicated is essentially what traders go with.
To sum it up, the issue is within:
-entering trading of smallcap niche without realization that cycles exist
-doing only a very rough data grab on tickers performance (for 500 samples), not segregated by cycles, will give too averaged behavior, which will cause issues later on—basically merging apples and oranges, rather than splitting them on each section, to find higher quality data on behavior.
-Smallcap indexes do not highlight cycles well because many active smallcap tickers daily are not part of Russell 2000, leading to more challenging to find methods for actual cycle recognition
-Black swan tickers are recognized, but mostly in hindsight only, providing little value in the mid-day on trading such tickers (to avoid large losses when needed). Many as well over-estimate statistically how much can single black swan ticker ignite a new strong cycle (as many black swan tickers fail to ignite).
Drawing a behavioral conclusion from apples and oranges,
instead of splitting apples into section one and oranges into section two for segregated expectations on behavior
Let's take the example of what happens to traders' accuracy of "behavior predictions" or trade losses or wins if the expectations are drawn across large data set of all smallcap stocks, versus if that behavior expectations are then applied into random time intervals and into random cycles.
The image above highlights what in reality happens to many traders who develop trading approaches that are very static and one-trick pony trading approaches. "Short gapper in first 10 minutes", "avoid shorting midday," "long, strong ticker in midday." If the trader picks just one of those approaches and then randomly applies it on tickers, using a very rough data on behavior that is drawn from large sample size but not adjusted to bull/bear cycles separately, it will often deliver frustration every so often; why is that?
Let's take an example from above, "longing strong ticker in midday, 12 PM."
With such an approach, the issue is, if the trader is not strictly selectively applying such procedure to the correct market cycle, it will yield frustration because the approach will, in some cases, deliver outstanding longs with ticker pushing 50 or even 100% into forwarding upside direction, consistently back to back (13 out of 20 trades will succeed in single month for example). And then there will be cases back to back on tickers where the trader will keep longing into tops, and each trade might fail ten times in a row (2 out of 20 trades will succeed in single month for example). This means that one month can deliver such approach with much different performance than the other randomly picked month, and since the method is very non-specific it will be prone to major exposure on the cycle it is applied. Make sure to re-read that last part, that is the key. All very rough or too broad trading methods (such as this one), are highly cycle exposed. They can do fine in one cycle and terrible in the other. Even that trader might find edge in it, due to averaging behavior over 500 ticker samples, the reality might be, trading of it will be a struggle due to big bumpiness in trading performance, as data was not cycle adjusted in first place.
It is not that unusual for tickers to be somewhat decently strong and hold in mid-day in strong and weak cycles. Still, the resulting behavior can be significantly different (end of the day market close). Meaning that in the weak cycle, it is less likely for the ticker to hold still strong by the end of the day, even if it is strong still mid-day. And if the trader does not calibrate his expectation based on the cycle, it would be no surprise why frustration due to wrong expectations would result. 20% difference in behavioral data could be a significant difference, especially for less accurate trading approaches with weak RR.
Therefore, segregate your data collected on specific pattern for each cycles separately, especially for really strong bull cycles and very weak cold cycles.
Expecting cycle to shift just after the fresh cycle has only started.
A widespread behavior I have noticed in small caps is that traders tend to get very quickly frustrated when there is a dull action in the market. For example, short-sellers get frustrated when the weak cycle lasts for while because the gapping tickers do not have enough "meat on the bone" to be worth a short trade due to limited RR. At the same time, the long traders tend to complain because traders place long positions early on and the tickers do not deliver any sustained push. And since duller or weaker market phases in small-caps are nothing unusual, the whole sector is prone to complaining, but it gets worse, into later stages of weak cycle.
Once this dull phase does shift into the strong mode, it is frequent to see that just after few days of the market starting to deliver significant moves in small-cap tickers that run 100 or 200% within a day, many traders enter into a "this is crazy" mindset very quickly. The strong market theme is still in infancy, yet they are already thinking, "this has to end soon; it's irrational, because they are still carrying the lagged baggage of frustration from previous cold cycle phase."
This type of behavior is very self-sabotaging because it is not in line with realistic expectations of how cycles work in this niche. In most cases, when the cycle shifts from one phase to other, it does not just end within a week. And just because a month ago typical ticker was gapping up 20% on average, and 2 weeks later it is gapping 4 times that, it does not mean that this cant last for a while. Having expectations on cycle to end too early when the new cycle is still young is a very unrealistic and poor mindset when it comes to trading any market asset, for that matter, not just small-cap stocks. This is especially true if the previous cycle was prolonged for a very long time, and now the new cycle is still very young. Traders just do not believe that this new cycle will last because they get so used to previous cycle lasting so long (regardless of being weak or hot cycle). This carry-over lag effect is messing with traders' minds across all markets, and its main root problem is lack of context.
On top of that, there is disbelief effect, where if trader observed previous cycle lasting so long, but only joined it right at its peak or bottom before it turned (caught at worst price), that trader is that much more likely to be in disbelief for this new cycle to have "legs further." In some markets, traders might get away with that type of thinking, and in some markets, they won't. Prolonged cycles have their special toolset in their use; they create annoyance without traders realizing it beforehand. The annoyance trap.
The explanation on why this happens is outlined at the start of the article above; due to no research on cycles or just using too broad behavioral expectations, "everything eventually fades (for short seller)" or "this tickers will rally strong, because last 20 tickers did" (for long trader), will lead a trader to un-accurate expectations on how the flows work within this niche.
Or from another angle, when a strong theme starts to deflate, many tend to miss the unwind. They keep repeating how the current squeeze-action day today is not sustainable and that this will end soon with tickers coming down. They keep shorting the market, but the market keeps squeezing them out, and often they give up and cut. After they give up, the timing then is right, and the unwind comes. And once it comes, the trader might complain of how he/she was right but now has missed the short trade.
In many cases, missing the initial first two days of unwinding does not mean that unwinding phase or the shift from strong into the weak market is done. This might (and it often does) still last for many more days. Often traders will throw towels too early just because they miss that best "meat on the bone" play and they want to time the top perfectly (if short), meanwhile completely neglecting what the current new cycle shift still has to offer them. Again it all ties back to having a correct mindset on how the cycles work. Timing a cycle does not mean, nailing a top. It means knowing that cycle is shifted (not too late since the top/bottom) as this now opens a sustained and prolonged price direction into that side which trader can join and extract edge from days and weeks. To extract edge from cycle, one does not need to nail the top perfectly for short seller, nor does long trader need to nail the bottom perfectly.
Plan your watchlist with the right expectations, using cycles as a top-down starting method
Market cycles are generally significantly underestimated or ignored concepts in any market. Traders are obsessed with finding their magical technical analysis tools, but they do not bother spending too much time finding how the big trends or cycles over history work. In, many cases it's because cycles might be too conceptual or noisy to figure out, or in some cases, because the market/sector keeps moving one directionally more or less through the entire time. But no matter what market you trade, your plan ahead of each day should be formed hierarchically from the highest chain that dictates the flows the most, which is the cycle itself. Get this right, and the rest of expectations might fit better.
When you create your watchlist for smallcap stocks daily, write some notes on current market strength over past 5-10 days. Your expectations should be influenced by the current cycle at least somewhat. Is the market potentially in a strong phase, or is it is weak phase, or perhaps more neutral (harder to conclude). This should be your rough outline because the expectations before anything else (dilution, tickers history, gap % etc...) should start from the currents cycle strength as a priority. Top-down approach.
Watchlist example, using cycle as the portion of expectation input:
Look left on chart but always prioritize right (recent action) over the left (older historical action)
Something worth frequently repeating, regardless of market traded, is that history is essential as guide, whether you are drawing historical price action levels (support and resistance) from the previous moves (overhead supply) or using the average gap % extensions for a specific ticker, from its previous gapping days, any such data will be helpful as guide for small-cap trading.
But do not mistake, a cycle that is extreme outliner can over-ride any data from history. Something that many traders tend to either overlook or just not getting to the correct conclusion about it.
What is meant by that is, for example, if the ticker has historical data of fading every single gap and has 10 of such repetitions, yet, the current market cycle is extremely strong with every smallcap ticker running into very unusually high percentage moves (such as January and February of 2021) the previous data is likely to fail if the trader is using it as expectation on today's move. Current cycle data will over-ride such past data and deliver a complete flip on the ticker's behavior, if current cycle is very strong or very weak (one per year usually).
This leads to fact, that knowing when to use past tickers behavior as guide, and when to completely dismiss it, and use "empty drawing board" instead, is very important, to not get married to wrong biases, under wrong situations.
Let me stretch this even further, if a trader used five different variables about tickers past behavior to determine current likely behavior within the Januarys and Februarys 2021s hot market cycle, the majority if not all of his data variables would deliver false expectations and would leave the trader with losses if the trader was not adaptive to cycles strength and adjusting the expectations to that. This is an example of how using data too static without having the right pulse on the cycle can lead traders straight into the slaughter without realizing; in such a case, the data will be more destructive than not having any data at all. Traders low flying auto-pilot is listening and relying on flying instruments that clearly show that there is no tall building ahead (because there was no building 5 years ago) using historical data, yet if one looks over the windshield, the tall building is clearly in front. Know when to disconnect auto-pilot and take full control over past data.
Using a very weak cycle would be the opposite example of the one above, such as in April of 2021. Again, if one had used just recent historical guides of 2021s early year as a guide, most of those would fail to deliver. The cycle has shifted, and yet trader has to recognize that and adapt with the expectations. The image below highlights how using past behavior, should be in-line with actual current cycle to be used as bigger weight to thesis.
If the cycle is weak, use past heavy fading behavior as bigger weight to your bias on the ticker, if the cycle is very strong and the ticker has past strong fading behavior, make sure to neutralize that data towards bias input much more. Use this variable (previous gap fade) as guide on how to perform same routine for any other data input.
When to adapt to new potential cycle?
A short answer would be: One week of consistent behavior should be enough to confirm the cycle shift. This means that over this one-week period, the tickers should be displaying very consistent one-sided behavior (for example, a large portion of tickers fading strongly for weak cycle confirmation) for a trader to identify that as a new cycle shift. However keep in mind, "fading of tickers" is just one of cycle shift confirmations, regard to the article above to know where to look for the rest behaviors.
In reality, timing quality will very much depend on traders' experience level. The more experienced traders and those especially focused on studying and observing behavior will be adapting to new cycles quicker. At the same time, those with less experience will need more time to spot the potential shift in the market cycle. That is entirely normal, and there are not that many shortcuts that one can take regarding that. Studying and trading market trough as many cycles as possible, and as well gathering as many hours within the small-cap sector to spot those cycles is at the end the only way to get quicker and better at spotting cycle shifts, in reality, all of which is achieved slowly over the years, not months or days.
Since cycles are typically shorter in duration within this market niche, the timing has to fit the average cycle. Timing the shift, ideal, decent and too late scenario: -In ideal case, if trader is very good at knowing what identifies a new potential cycle, several days might be enough to spot the cycle shift.
-In a more realistic case, two weeks would be the soft spot where most traders will probably fit.
-Anything more than three weeks might be already too long/late, because that might already be near the cycle end.
The one week is just a rough outline that might be more suitable for a broader range of traders from less to more experienced; in reality, there is no specific time crunch that traders should apply as a filter to when new cycle might begin. As mentioned early in the article, the cycle can shift within just a day or two; the length of the fuse that the trader wants to use as an identification of shift will mostly depend on the experience and how quick the trader is at adaptivity and how robust his/her method is to spot the shift as quickly as possible, without the method to achieve it being too complicated. It is this balance that will dictate how long/short the fuse on cycle shift recognition should be.
Track the % spikes intraday, day 2 fade or rally results, and else.
There are many ways how a trader can be tracking the cycles and spot potential shifts using the one-week guide from above. A simple approach might be just to note down some data points into the spreadsheet or perhaps some basic custom built indicator that lets the trader know which conditions are currently present for a trader to identify the cycle better.
Some decent data points to track on day to day basis, per each ticker:
-% move on the day for ticker
-day 2, did ticker fade or rally higher
-did the ticker fade straight from open or did it extend decently in the first hour
-is a recent hot/hype theme present in the market or not (such as EVs, weed stocks..)
An example would be, if data points over past 2 weeks show that every (15 out of 15) ticker has faded on day 2, that data is in-line with weak cycle behavior. The more noisy the day 2 performance on ticker is, the more it points towards neutral cycle, or the stronger the day 2 tickers are over 10-20 sample cases, the more such behavior hints towards stronger cycle. This is just an example of how one such data point can weight or point towards what cycle might be present.
Those four data points are very crude, but they should give traders a decent starting point. The rest is up to traders on what additional variables to check and collect daily, but whichever data points you choose, make sure it is robust and not too complicated. If the data input is too complicated and takes too long to collect on daily basis, it will make collecting too tedious, and trader will either get sloppy or abandon it. Make sure not to make the process frustrating; else, you won't stick to it.
The conceptual guide of the four variables provided above would be and their relationship to cycles:
Careful on using the absolute volume numbers as guide for cycle indication:
Using intraday traded volumes as cycle indication (high volumes in the strong cycle and low volumes in the bear cycle) is not a good idea mainly because it is not accurate and is very deceptive since volume numbers can shift rather significantly from year to year, which means that the volume numbers that trader would be using from 2019 could be substantially lower to identify cold cycle relative to the typical cold cycle of 2020. Market volumes can increase or drop over the years, and using some absolute numbers as a guide is not a good idea (only perhaps if used back to back, compared to latest previous cycle of this year).
Also, if the market enters an extremely hot bull market and then starts to unwind, the unwind volumes on tickers in the cold cycle (following the strong bull cycle) could still be significantly higher in such cases relative to the bull cycle from a year ago. For example, in March of 2021, the unwind / cold cycle started to creep in the market slowly, yet the volumes traded were far higher than any bullish cycle of 2018 or 2019. A trader using volume gues as cycle indications would likely be kept in the dark for way too long and coming to wrong conclusions. If one was to assume that bear/weak cycle would only start in 2021 when the volumes drop under the typical bull cycle of 2019, that thesis would never come true. Which is why relative current (freshes) context is so important.
Keep this relative picture in mind, as the market volumes and activity can shift strongly over a year-to-year basis. The method used to identify cycles should be scalable and adaptable; it must not be static in absolute terms, especially not when it comes to volumes.
Asymmetry within the small-cap stock cycles makes the adaptation that much more critical.
Small-cap stocks, unlike many other markets, have very fast-changing cycles and a lot more noisy durations. For example, specific cycles tend to last only a short while, such as two weeks, while other cycles might last up to two months.
This often means that traders might start to adapt to a new cycle as behavior suggests so. Still, then that behavior shifts all of a sudden firmly into the opposite direction with consistency. In such a case, a trader needs to flip from Plan A to Plan B back to Plan A in terms of hot/weak/hot cycle expectation, or perhaps weak/neutral/weak. Due to the more considerable asymmetry of behavior within smallcap stocks, that is entirely normal, and traders should get used to it. It is fine to flip flop opinion on day one and then day three. However, if done so every day, 15 times within the same month, it would be too much and signals that traders' method to cycle indication is not robust enough. It was not smoothed out enough.
If that is compared to cryptocurrencies, for example, the cycle behavior there is much more symmetric, or the large-cap stocks as SP500 using as leading cycle indication. The cycles there are much more mathematically / time-symmetric. Smallcaps, on the other hand, are far noisier, which makes the need for being adaptive that much more important, it makes spotting the cycles correctly as well more difficult due to that.
The statistical data and historical behavior is what gives the trader a robust approach to markets. Still, if the markets behavior is noisy, the adaptivity and improvisation is a necessary skill because being too static will not be acceptable. Realize that when you are facing the small-cap sector niche.
Strong small-cap cycle
Typically strong cycles provide the most opportunities in a small-cap niche, regardless of whether the trader is long or short biased. Strong cycles expand the volatility, provide more intraday ranges and opportunities, make tickers less prone to very early fades, and provide just more trough-entire-day opportunities. This means that potential R units that traders can extract from tickers will be highest in strong cycles, and those are often the phases that traders tend to focus on the most.
Strong cycles are met by certain micro behaviors, which are trickier for short-sellers and slightly more forgiving for long traders. For example, a fake breakout might reclaim to the upside, somewhat more likely in the strong cycle, giving a trapped long trader on breakout a recovery chance to exit at breakeven. Or a stock that drops 50% from its highs, while long trader being stuck in trade, might still reclaim back to its previous highs within days giving such trader another exit at breakeven opportunity, something that is much less likely to happen in the weak cycle. Therefore, stronger cycles are more forgiving to long traders on their mistakes, especially if they are sloppy on trade management.
Strong cycles are usually the market phases where very new traders will learn the worst lessons and carry them forward if the market forgives and rewards them (for long traders) by reclaiming their entry prices while initially being at a loss.
As trader gets more experienced this however can be used as an advantage. Knowing that ticker might recover still somewhat more likely might give such trader a wider room to manage the trade, as long as the size is under control and uses hybrid approach to scale the trade.
Each year in small-caps, there are about two very strong cycles, two medium-strength cycles, and a few or several smaller micro-strong cycles. The more bulked those strong cycles might be together within a short period (for example, three months), the more likely it is that the market will soon dry out and enter a prolonged period of "desert" phase. If such behavior is present, a trader should be ready for it ahead. The less the same cycles are bulked together, the more market "breathes" and re-calibrates the flows, giving each new cycle a decent length before the new shift.
Fake breakouts (FBO) and rug pull in the strong market cycle.
Under a strong cycle, the fake breakouts tend to have a noisier behavior.
If it is expected from fake breakout to deliver the further downside flush, then this is often what does not happen under a strong cycle. The fade is either very short-lasting, or there is no fade at all, and the price reclaims the FBO level quickly. Similarly, when a rigger or large participant flushes a high volume of shares in rug pull, there won't be unwind following such rug pull candle in the strong cycle. Instead, the price might more likely reclaim 50% of the rug pull candle and push higher.
To keep it simple, in the strong cycle, the fake breakouts or shakeouts (pulls) get very noisy price follow-through, sometimes with decent followthrough but often not as there is enough fresh demand coming through for rigger and other market participants to keep pushing ticker higher, even after what seems an ideal topping signal.
Therefore, in the strong cycle:
-after the fake breakout, the price is less likely to follow lower with the deeper further selloff, or if it does, it won't be a large selloff
-after heavy rug pull price is less likely to follow lower with the further selloff, or if it does, it won't be a large selloff
To highlight the behavior with conceptual image:
In a strong cycle, try to trade such stuffed or fake breakout levels, or rug pull candles as long plays instead, once they start showing indication of reclaiming rather than fighting those to the short side. Or with other words, instead of trying to short fake breakout, avoid it, and just wait for reclaim to long.
Example of fake breakout on ticker DTSS and quick reclaim following:
HOD clearouts and price behavior followed after clearout in the strong cycle:
Often in the strong cycle, Type 1 HOD clearouts will swipe the structure to the upside, but instead of price pulling back down deeply, it will pull only some amount and then soon enough reclaim the HOD level again and push higher. This makes shorting HOD clearouts less ideal as RR is smaller, and it is more likely for a trader to stop out as well. Not highly likely, just more likely relative to shorting them in the weak cycle, for example.
Example of rigged ticker OBLN in the strong cycle, with three traps and HOD clearouts, but 2 of them not delivering rejection and fade after clearout, only last one did. For example, in the weak cycle, it would be common to expect that after HOD swipe, the price would shake out shorts, then top out and fade straight from there into deep selloff. However, in a strong cycle, the opposite often happens. Price swipes HOD on the rigged ticker but just keeps going higher. An important distinction to make on this micro behavior.
Expect more Type 1 plays in strong cycles. This should not come as surprise; in the strong cycle, the demand influx is higher, therefore likely to sustain ticker, which increases the chance for Type 1 play (ticker has to hold consolidating 1 hour or more for Type 1 to come into play in first place).
Ideally, a trader should be trading those to the long side in the strong cycle and both long and short side in the weak cycle. The reason is that the rotation long into HOD clearout has a higher probability in strong cycle. In comparison, there is a lesser probability of rejecting and selling off after HOD clearout due to sustained demand pressure. Play it to the long side instead, follow three or more lower highs and then plan your long towards later hours before EOD push. Or if not that, at least make sure to differentiate the sizing on positions, if the trader is playing both sides to size more on long plays in stronger cycle of Type 1s (more size on long, less on short).
Example of Type 1 on ticker FTFT:
On the image below is Type 1 (read previous articles on rigged stocks to get familiar with Type 1) on ticker OCGN with AH combo squeeze and clearout. Example of ticker that combines all the leading variables of a strong cycle. A solid example of why a short-biased trader should not be swinging short such a ticker; if all on the article mentioned is implemented, the probabilities were not in line with a downside, at least before that HOD swipe is completed.
Another example on early HOD clearout of ticker SCKT where no fade was delivered after initial clearout. Instead, ticker rallied much further. The example below is why a trader should differentiate between Type 1 plays in strong and weak cycles since price reaction after HOD clearout can be quite different. Not just that, but also if the trader is long into clearout level, the price might over-perform expectations on where trader thinks the price might starts to turn.
Or to keep it in more straightforward words, if long on Type 1 plays in the strong cycle, keep some long size running for higher, as plays tend to outperform stronger run than possibly expected. And if shorting, make sure that clearout level presents a very heavy volume anomaly before attempting the short, else rather avoid.
Multiday runners behavior (and chances of happening)
Strong cycles are frequently met with higher numbers of multiday runners. The chances for tickers to hold day one and push either into after hours or the next day aftermarket open are much higher in strong cycle relative to weak cycle. This is something that swing-based traders should observe closely. There is no excuse to be forcing short swing or long swing position without having a good pulse on overall cycle, or ignoring the cycles strength or weakness.
AH plays in strong cycle
Just as multiday runners are more likely to happen in strong cycles, the AH plays with rallies in the first 3 hours after market close are more likely to happen in strong cycles. Make sure to use (if identifying the current cycle as strong) this to your advantage. Especially consolidated tickers that held through the day well, such as ticker SENS below, are likely to turn into a further AH runner.
Parabolic runners in strong cycle
When a strong cycle is in its full momentum, pay attention to parabolic extensions (check another article on parabolic extensions if needed); the reason is twofold. First, the parabolic plays offer great opportunities to the short side. Each time a topping offers decent RR on trades if timed correctly, or from another view, traders anticipating potential parabolics in the strong cycle will be that much more careful and patient on shorting later rather than earlier.
One of the very common mistakes is traders who do not pay any attention to the current present cycle tend to get caught in shorting extensions or parabolics too early in strong cycles, which often over-extend strongly and cause them big losses.
When in the strong cycle, a trader should expect many more tickers to turn into parabolic runs than it would normally be present in weaker cycles. In a strong cycle trader, if short seller, should not be sloppy on trade management (add, add, add) if shorting early into extension because it might turn into a parabolic move, causing large drawdown or loss!
Example of parabolic run on ticker ADTX in the strong cycle:
Another example of parabolic EOD runner on ticker DVAX. Mind that parabolic runners in strong cycle can happen at any hours, either early market hours or late. Often traders tend to confuse the fact that parabolic runs are primarily only in early action due to volume activity, which for strong cycle is not the case, since demand is present across all hours more evenly. Ticker can enter into parabolic phase any hour trough the day in strong market cycle.
Keep this basic fact in mind when a strong cycle enters. Statistically, this is the most likely when parabolic runners will appear. Just having this fact in mind can save a trader from larger losses or potentially extract better rewards on the long side. This is a very powerful yet overlooked fact that many traders neglect, in all markets, not just small caps. And this goes both ways. Often, traders expect parabolic runners in weak or bear markets just because they saw it a few months ago. Forcing longs with strong parabolic runners' expectations in the weak cycle is just a no-no; it will fail way more times than it would deliver. Parabolic moves have a strong correlation to strong cycles.
Macro short squeezes in strong cycle
Under strong cycles, traders should certainly keep a closer eye on macro short squeezes on higher time frames. The tickers exposed to this theme will be strongly consolidated tickers where the price has been trading within a tight range for 1,2, or 3 weeks, absorbing a lot of short selling liquidity around very similar prices. All this packed short liquidity of swing traders will then be used as fuel on the squeeze once the larger players initiate the squeeze. Tickers that traders should keep an eye on are especially multiday runners, ignited with major rallies some weeks before but have not yet faded much, as those will have the highest amount of short liquidity present (highest short float %).
Traders should make a list of all potential multiday running small-cap tickers and keep an eye on when the rotation with first higher highs starts taking place. To sum up, the variables:
-ticker is a multiday runner from recent history (past two months)
-ticker has held at least 50% of the whole rally or higher
-ticker has consolidated for at least two weeks
-ticker has reported a high amount of short interest % present (above 35%)
Conceptual presentation of the chart trader should be looking for macro short squeezes in the strong cycle, or after it (since some of those tickers might actually squeeze after strong cycle ends) .
Some of those tickers might trade options, which is often an even better RR way to approach the short squeeze play, buying call options with 10 days expiry for example.
This play is specific to strong cycles, as the win rate drops significantly in a weak cycle of small caps if traders were trying to trade it to the long side. An example of how the cycle can make a large difference to patterns performance, not all patterns will be strongly exposed to cycles in terms of their performance, but many are.
Example of a macro short squeeze on ticker VXRT under hot/strong cycle of small-caps in mid January of 2021. A grade example.
Example of a similar short squeeze on macro but in a later colder cycle which might offer some ignition into stronger cycle forward here on ticker EXPR.
Macro accumulations on multiday runners and 50% strength rule
Example of a macro short squeeze on ticker APHA that was under held of both rules explained above—held 50% of range for a while with strength, and it rotated above key highs still within the strong cycle and delivered squeeze further. Those tickers are often good swing longs if done under a strong cycle.
Pay attention to themes and sympathies and the behavior of the leading ticker (often ignitor)
Each strong cycle in small caps is slightly different. Some have very strong themes, where many tickers of the same sector will be running for weeks along, such as the EV sector example from January of 2021. Meanwhile, other strong cycles are smaller in scale, where only a single frontrunner with several sympathies will be the critical runner (Biotechs in 2019 March), and all the rest of the tickers of the strong cycle over the next few weeks will be mixed sectors without any real correlation. Therefore, some strong cycles are a lot more mixed in the content of assets running hot, while others are more unified.
But regardless of which case it is, always make sure to study the critical-lead running ticker and initial sympathy (first few that started cycle) very well. Get to know with what sector it is, what the pulse on social media is, and why the market is so excited about leading ticker, for good or for worse (regardless how right or wrong the general market is). It matters because it can help you spot new running tickers ahead before turning into strong runners. Always study the story behind why the leading ticker keeps running and how that might ignite further legs on other sympathy tickers.
Examples of strong cycle hot themes (recent two years):
-EV (electric vehicles)
Use the strength of the leading ticker to establish further momentum on the cycle
A conceptual example of ignitor or leader versus the smaller cap asset performance and complete deflation once leader tops out, critical to determining when the hot cycle might end. Pay attention to the lag in reaction of sympathy tickers or smaller assets relative to leader, that lag is critical to extract more edge:
Example of ticker TSLA as leading ticker and frontrunner to the many EV tickers that later followed under strong cycle in early January of 2021. The relationship between those worked just the same as it did for crypto and Bitcoin (leader) just few months after that in May (on the second picture below).
Both TSLA and Bitcoin as leaders above highlight the same pattern. The same will be applied to pretty much any market niche; mentioned only difference is that for small caps, those leading assets tend to come and go in different forms; in some cases, it might be large-cap ticker that is ignition leader, while in other cases it might be small-cap ticker that is the actual leading ticker for strong cycle and its momentum.
It is very handy to have a broader market interest and research to always have the pulse on those leading tickers as often they do not come straight from smallcap land, as it is the case for TSLA and Bitcoin above.
For anyone willing to take this article seriously and not just a one-hour weekend reading task, make sure to research in-depth what was said above for TSLA and Bitcoin's relationship to the smallcap assets. Research as many tickers as possible and the strong cycle correlated to each of those tickers, and how the momentum shifted after critical breaches of support levels.
It is one thing to read about it, it is completely something else if in-depth research is done, but when it comes to learning about cycles, it should be said that live experience is by far the best teacher on it. Some things are great and better to study historically, but from my experience, developing a good pulse on cycles is mostly done through applying the right views through decent historical research (foundations) that is then observed daily on live markets, over months or years. Live experience cannot be substituted by anything else when it comes to developing pulse on cycles.
The ignitor of a strong cycle
Each strong cycle is ignited in small caps by the front-runner, ticker with significant % move and plenty of attention and interest from public. Unlike many other bigger markets, such as large-cap stocks or crypto, where the ignition is usually led with a more common market force across several assets, in small caps, usually, the ignition is lead by one or two assets at once, not more.
Spotting cycle shift is about understanding all the mechanisms that signal potential cycle shift. Never isolate single behavior as possible cycle shift ignition, as that is frequent mistake made by beginners. Everything has to line up well from all angles, for cycle shift to be identified.
Therefore, never isolate:
-strong % intraday runner as "confirmation" of the market shifting into a strong cycle (because more often than not, this running ticker will not be enough to ignite new strong cycle)
-one ticker rallying in AH and holding its intraday gains with a gap up next day as "confirmation" of new strong cycle
As mentioned, beginners or too bullish-biased traders often make such mistakes, which statistically delivers poor performance on timing the actual real cycle shift well. Why? Because it is not enough. To confirm cycle shift, everything has to line up across the different spectrum of variables. Both of above cases outlined are present in strong cycle, however they are not by itself enough to confirm a likely shift in the cycle.
One thing to keep in mind, just because smallcap ticker goes parabolic at a 300% intraday run, it does not mean the strong cycle will ignite by default. Strong intraday runners and strong cycle ignitions are not necessarily the same concept; however, they can often go hand in hand. Meaning that for a strong cycle to be confirmed, other conditions have to be present, such as 1.larger number of sympathy runners. 2. Increased numbers of multiday runners. 3. Increased number of AH tickers with rallies in low liquid market hours (as this shows the urgency of buying) . 4. Higher than usual volumes present on most tickers each day, compared to the previous month.
To sum it up, to solidify the fresh presence of strong cycle in small caps, make sure those behaviors are present within the past few days, at highly elevated numbers of cases (relative to past 2 months, since what matters is context):
-multiday runners which keep pushing since day one (at least three days)
-tickers that push 50% in the first few hours and holding gains somewhat decently, rather than fading straight away, should be present at much higher numbers relative to the weak cycle from a month or two ago.
-at least a few sympathy runners have to follow igniting ticker without any catalyst being present at them. It sounds weak variable, but in fact signals, strength not weakness, if present in the right context.
-AH plays and rallies are not rare, instead of many tickers are pushing each day in AH higher
-At least two tickers with 300% runs recently should be present
-cumulative volume numbers across the past 20 tickers should be much higher than 20 randomly selected tickers a month ago from the weak cycle. All strong cycles are met by elevated volumes across the majority of tickers.
-tickers with strong bearish fundamentals, dilution, or even intraday offerings can hold well or even report freshly sold ATM (in size of 100 mils, for example), the ability for tickers to hold strong and even push under such conditions will mostly be met in stronger cycles only. In a typical weak cycle, the intraday offering will destroy the ticker, or the ATM will capsize the multiday running ticker and send it south relatively quickly. The inverse of such behavior is the presence of a strong market cycle where the fresh demand and hype volumes are able to absorb the unloading.
An example for strong cycle ignition on ticker BPTH in March of 2019 is shown on image below. Typically the cycle ignites with a single ticker rather than having ten tickers at once, pushing with strength and waking the cycle up. Often for small caps, the ignition is done by a single asset, and it could be rather random to anticipate which one that might be. The point for a trader is to understand the three-stage process under which the new strong cycle might get solidified. This is critical to understand as it will allow traders to recognize new cycles as early as possible; any day lost is a loss of adaptation and could make a significant difference.
The first stage is after the ticker receives a positive catalyst, and rather than fading, it is holding intraday quite well. At this point, this is not enough to ignite the cycle since this is not that rare behavior; in many cases, the tickers tend to hold strong after the first day just to fade the next day, especially rigged tickers. What makes the difference is going to be those extra two or three days. Is ticker going to able to sustain strength second, third, and fourth day with increasing liquidity? Usually, the tickers that belong under igniting ones will perform such behavior.
The second stage will be the transition at which the ticker holds those initial first-day gains with continuous pushing higher and some decent volume participation.
The third stage will be the parabolic move, or a sustained forward movement of a multiday run higher, which might not necessarily be parabolic, but just a continuous run higher.
Stages as outlined above shown on the ticker BPTH below:
On the second and third stage, a trader should be noticing a higher / elevated number of sympathy tickers and just smallcap gapping tickers each day, which is always a necessary condition to confirm that a strong cycle is now potentially staying.
Under most strong cycles, there are few tickers along with the main igniting ticker, which can push very high % and hold the gains at the end of the day with AH run.
One of the important indications of strong cycle presence will always be the number of tickers performing decent AH (after hours) rallies. In a weak cycle, AH rallies are rare; one out of ten tickers might be able to do it. In a strong cycle, the amount of AH rallies increases in percentage terms significantly, up to severalfold (five out of ten tickers, for example). This is an important variable for a trader to look for as it is relatively non-complicated and can help a trader build stronger conviction on cycle shift confirmation.
However, make sure not to confuse any single variable as cycle shift confirmation. Just because on one day there were few tickers running in AH, it does not solidify the strong cycle just by looking at that behavior itself. Everything else has to match it as well; all components matter. As stated before, cycles are like soups of variables.
But keep in mind as well, since there is no confirmation from the public or any indicator that "confirms" when the cycle has really shifted, it will be upon you as an individual to put the foot down at some point. Pointing this out because one must be practical and not too scared to put a label on what type of a cycle the market might be in. If you are too slow and looking for too many confirmations, it is likely to be too late at identifying the new cycle shift. The reason why majority of beginner traders or investors only spot the strong cycle right before it tops out and spot the weak cycle only when it is about to bottom out and shift, is because they are too laid back looking for too many confirmations. When things are already very obvious with tons of confirmations, chances are this is the top or bottom of the cycle and the end is near. Or with other words, the actual cycle shifts happen under the noses of the majority of market participants without them noticing it.
Numb your senses and skepticism when in strong cycle
It is always interesting to observe strongly bearish biased traders, especially those with plenty of experience and very detailed fundamental knowledge when the strong cycle is present. Under strong or exceptionally strong cycles, those traders will often struggle the most. Their over-skepticism will be their bottleneck to adaptivity. That same healthy dose of skepticism that works very well for them in weak cycle will be the issue in strong cycle often.
When the market gets into very strong hype state, even though it might not last that long, the hype can create very irrational moves, and it is not a good idea to be using too much rationality to justify what ticker might or might not do.
Remember this, when trading strong cycles, your skepticism sensor should be intentionally weakened for a certain period of time, especially if you have been able to notice the shift of cycle very early. It is highly rewarding to be very bullish at the start of a strong cycle. It is highly problematic and damaging to be overly skeptical at the same time. This is something that still troubles many experienced traders as it takes real flexibility to master it.
This point goes especially towards more experienced and fillings digging traders; try to lower your "common sense" down when you are in the early or middle stages of a bull market. Having a stronger default bullish tilt towards tickers will help, and being far more careful and patient on shorting will help avoid getting caught in squeezes. Trading markets is not really about being right or wrong on the idea; it's more about identifying the pulse on flows and joining the right flow; often experienced traders get to being obsessed with "seeing the right or wrong side" rather than noticing the strength of overall flows.
This does not mean that one should just close both eyes and press the buy button at all times; however, long plans and trades should be by default more present than short, if possible. Or at least, if the trader is short only, to know how this means an adaptation with more patience is needed.
Conclusions for strong cycle
Make sure to check examples on the article below for weak cycle on behavior and flip them around for what to expect under a strong cycle.
If it is expected for Type 1 HOD clearout to deliver straight fade in the weak cycle, then expect potentially more tricks and reclaim the price if the cycle is strong.
If it is expected for the price to follow through to the downside after the fake breakout in the weak cycle, in the strong cycle, the fake breakout level will likely be soon reclaimed with the price pushing higher again, not too long after the fake breakout happened.
To keep it in simpler words, in a strong cycle, what might be a typical bearish pattern will have a higher chance of failing to deliver a strong downside and might soon instead be invalidated by reclaim and push higher. This is not to say that this always happens or to a very high degree; it just happens far more frequently than it would in the weak cycle. As a short seller be tighter on risk and more careful when trading in strong cycle, and as a long trader one can afford to be slightly more looser on risk management and entry accuracy.
Weak small-cap cycle
The weak cycle in small-cap stocks has a more inline macro behavior under its direction. What is meant by that is that, in general, small-cap stocks tend to be a downtrending on macro time frames due to many structural and fundamental reasons, which is better in line with the cycle that as well follows such trajectory (bear on bear play). From a fundamental perspective, it makes more sense to see small-cap ticker fade on an intraday basis rather than rally strong and then hold such gains into the next days.
There is also a somewhat higher correlation of clean behavior from statistical or performance viewport when the sector is in the weak cycle, meaning that the tickers will fade rather consistently. Their behavior will be less noisy than in the strong or neutral market cycle, mainly because it will be in line with the overall larger macro downtrends. When a small-cap sector is in a very cold phase (weak), the demand is very lacking, the volumes are low, and usually, sellers (trapped buyers from higher prices) will get any chance to exit their positions break even if they get a chance, which means that supply is always present, but demand under such cycles is lacking. Therefore it is not surprising that under a very weak cycle, the tickers tend to fade relatively well and at higher % rates.
On the other hand, due to decreased demand and decreased market-making activity, the gaps are also smaller. On each catalyst, stocks tend to gap up less and tend to push less as well from the market open. This makes it difficult for short-biased traders to participate since the RR (risk to reward) will be capped. And often because many traders are taught to "always wait for some push before shorting," this all adds to the issue that many just get left out of trades under such a small-cap cycle.
Overhead supply in weak cycle
In a weak cycle, traders should be looking at the macro chart where the overhead supply and trapped longs are present on the ticker from previous runs. It is more likely for supply to be in control of tickers in the weak cycle, and therefore any extra fuel of selling from overhead supply levels can help. Overhead supply should be more valued and prioritized in the weak cycle and less in the strong cycle since in a strong cycle, there is more fresh demand present to absorb the trapped buyers from previous runs.
Adaptation is necessary for a weak cycle.
It is essential for traders to adapt the trading approach slightly under a weak cycle. From my observations of hundreds of traders, what tends to happen to traders who do not adapt is that they come with the same entry expectations in terms of price behavior from the strong cycle, and then after a week or two, trader starts to wonder why are they getting left out without any fills or entry opportunities on short trades. In the weak cycle, the extensions from market open are smaller than in typical neutral or strong cycle. The chances are higher for the ticker to fade early rather than late. The chances for the ticker not being able to hold through the mid-day without already being at the backside are higher. The liquidity is lower, etc., etc.
All of the above data points to the fact that if a trader comes with the same approach from the hot cycle into the cold one, he/she will get left out of action, which is essentially what happens to many. The above suggestions are meant for short sellers, long biased trader needs to adjust as well, but in a different manner. Mostly being more eager to sell gains earlier, and potentially avoiding longing lower liquid tickers as those are somewhat more likely to fail.
Example of adaptation in weak cycle for short seller in terms of entry anticipation (for short seller):
Adjust your entry locations, your RR, and your fade targets (for short-sellers)
In a weak cycle, a short selling trader has to adjust three main components:
-entry location (pre-planned area of short entry should be lowered, trader should be more aggressive and pressing earlier with short)
-risk to reward expectations (a trader should be satisfied with less R per trade relative to the strong cycle, because in weak cycle tickers have less range).
-fade targets (should be extended deeper, trader should be more patient on closing gains)
Same rules apply and stretch to long trading as well, they just apply at inverse relationship.
Let's address the first one, the entry location. When in the weak cycle, the ticker will push less of price distance after the market opens. Traders should therefore lower down expected maximum push that price could or should achieve. This is something that, to many traders, looks pretty unnatural and strange. It makes them feel like they are chasing into lower prices of the ticker (short sellers). It is essential to get comfortable with this uncomfortable way of approaching the trades in the weak cycle. It is not what the trader believes it is right to do; it is what cycle and data suggest that matters. Trading ideas are not about right or wrong of what you decide to be right; it is about defining right or improper action within specific context of behavior.
Therefore lower your entries in the weak cycle, which also applies to the recycling of positions. A trader should recycle on pops faster, meaning any decent pop or retrace of the price you get to the upside should be re-shorted earlier rather than later because chances are there won't be many strong pullbacks present.
If you must, split the entry into few entry price points rather than single entry if you are not comfortable shorting "early." Or perhaps take earlier cuts and re-short if needed. Again this is up to everyone to figure it out by themselves; the article only points out clear behavioral facts that trader has to take into account and adjust the trading approach.
Example in difference of lowering the expectation of entry in weak cycle versus neutral cycle:
Risk to reward expectations
Let's address the next component, the RR, or risk to reward. This is where it gets interesting because most traders do not use market cycles as adjustments to their RR expectations. Let me explain why that can easily do damage to trading performance and mental capital frustrations. Trader has to be adaptive, and forcing same "set and forget" RR approaches (for example 1:2 on every trade) is just not good way to go, as trader is forcing his/her own expectation and trying to corner the market, where the market might not be in best state to provide what trader wants.
When the liquidity in the market dries out (in weak cycle usually), and the market enters a very cold phase, few things will happen. First, the spreads will widen; wider spreads by default decrease the RR on trade. On bigger spreads, the trader will often stop short trade on the ask if using a market order. The stop-out distance will usually be slightly wider than initially planned, and the same goes for the long trader; the long trader will stop out on the bid. With bigger spreads and weak liquidity, the loss will be slightly more significant than initially planned. Additionally, there are practical issues getting harder to fill on trades, which often pushes traders to chase market orders into broader spread assets to ensure they have been filled and not getting left out. Both of those processes over a large sample of trades by default lower the RR whether the trader realizes that or not.
The next issue is that the ticker will have less substantial pullbacks under a weak cycle, offering traders fewer recycling opportunities. It is not uncommon that the ticker fades straight away in the weak small-cap cycle without looking back. Recycling is one of the better ways to increase the RR and Rs collected on trade. If the cycle by default limits that ability, it decreases the RR; whether the trader wants it or not, the cycle enforces it.
Example of behavior in stronger or weaker cycles on small-cap stocks. This is a rather very crude simplification, but none the less it will hold to a significant portion of the asset; just to some, it will apply more and to some slightly less.
Another point to raise why the RR by default will be limited under weak cycles more than under stronger cycles is the range or volatility on the asset. Under weak cycles, the gaps are usually lesser % in size, and the tickers tend to have more difficulties pushing strongly, which decreases the range on the ticker given.
Smaller range on ticker will instantly limit your RR on trade. There is very little that traders can do to increase the RR in such cases. It is common to happen under a weak cycle.
Let's compare two tickers, one under strong cycle and the other one under weak cycle, and how typically limited range under weak cycle decreases the RR on trades.
Example of ticker in strong cycle and high volatility / range:
Example of ticker in weak cycle with low volatility / range:
It is common to see that traders form their appetite for their daily goals in R units, but they do not adjust their expectations when the cycle shifts. It is normal to have bigger expectations in the strong cycle, but in the weak cycle, especially on low range ticker, it is not normal to not lower the standards and go for lower expectations. Not just in regards to potential Rs collected, but the RR itself on each trade. In my view, every trader should adjust to that; going with too high expectations under the wrong cycle is not a good idea. And this applies equally to both long and short traders. In reality, regardless of the side, one is trading in, under a strong cycle, everyone has better RR on trades, no matter if you are a short seller or long trader; meanwhile, under a weak cycle, the RR drops, again regardless of the side you choose to participate on.
Conceptual image to outline the expectations and correct adjustments for weak cycle:
Impact of commissions on trades in weak cycle
Something that is often not discussed much is the impact of commissions on traders' performance in weak cycles specifically. When the range on tickers drops along with liquidity, the tickers will have larger commission impacts on performance, especially on a per-share commission basis as traders have to enter into bigger share position sizes. When the range is weak trader has to borrow and enter short more shares at once to squeeze some decent P/L out of small ranged ticker than the wide-ranged volatile ticker. This also applies to long traders, just that their impact is more minor because they do not need to borrow shares to enter a position.
Why is this concept important to know? Because it also dictates your RR on trade. If you want to stay within specific % risk on each trade, then there are only so many shares you can enter in a particular position. Still, as well in some cases, if the ticker has a small range, it also means the trader will have to step up and borrow and fill the required position, else the position will be undersized. And this will then likely increase the commission costs on such trade. One trade might not make much difference in traders' short-term view. However, once looking through historical data of commissions for specific traders over a large sample of trades, there might be a severe difference in impact.
Deepen your fade targets and increase your patience
Perhaps out of all adjustments that traders should make, the most straightforward one and the least challenging one is to be more patient and let the ticker fade deeper in weak cycles relative to strong cycle. Or in other words, your covering timing should be much more weighted towards close market hours (EOD) rather than earlier hours after market open, for short sellers.
Increasing patience and achieving that with whatever method necessary is usually less challenging than telling a trader to lower entries. This article won't go into details on how to calibrate the right amount of patience, whether you use sticky notes, reminders on the phone, a fellow trader who reminds you of intraday. That is up to everyone to figure out by themselves; the critical point is to realize, it has to be done. When a cycle is weak, be patient with faders. When a cycle is strong, be more eager to cover early.
This "patience" can be reversed if one is a long-biased trader. One should be much more impatient for a long biased trader when trading in the weak cycle, taking gains off the table earlier.
ADF (all day faders)
It is not uncommon that when the cycle is weak, the all-day fading tickers increase in numbers, the tickers that fade straight from gates open until the market closes. Under a very strong market cycle, there might be no ADF ticker for weeks. It is important to adjust this expectation.
As mentioned above, one very robust way for a trader to increase the fade targets is to use time as the leading factor in covering position. Often traders ask questions, where should I cover this fading ticker, what are indications to tell me when to cover, is there something from pre-market action to look for as support?
There are many ways to go about it, but my rule is a combination of few factors, but because some of them are difficult to explain in the short article, let's outline the two most important ones—the time plus the gap % fade.
By gap % fade, it is meant that the approximate fade target trader should be looking for 70-80% of gap fade under a weak cycle. Where ticker closed at the previous day in after hours, and then started to trade in pre-market today and then up to its pre-market high is what counts as the whole measuring distance for the gap fade. So that distance has to be met the 70-80% from its highs.
The example below on how to estimate gap% fade since market open:
The mechanics above only applies to all day fading tickers with strong presence of supply
By the time, it is meant the hour at which the trader is considering covering the position. The ideal hours should be closer to the market close, especially the last 3 hours, but this largely depends on how quickly the ticker starts to fade. If the ticker starts to fade very early and fades significant % within an hour or two, then the trader should be considering covering a more substantial chunk of position earlier, as it is less likely the ticker to fade too strong over the next hours once liquidity dries out, if ticker already quickly came down. Meanwhile, if the ticker initially is fading less, often the panic will set in closer to the EOD hours, and traders should be more patient to wait for real flushing in the last 3 hours and be more patient on covers towards later hours.
Example of using time component as a cover target on ticker ENTX:
Another component that matters is the amount of % gap that ticker still has to fade around 1 PM or later. The more meat on the bone, the better, the more patient that trader should be on covers. Meanwhile, the less meat on the bone ticker has (ticker already fading strong portion of gap) by 1 PM, the more inclined the trader should be to start covering because it is not likely that ticker would still begin to fading strong. In most cases, the liquidity in such cases will already be very dry.
Therefore, the gap % fade and the "meat on the bone" are correlated variables that go hand in hand. For ticker to have plenty of meat on the bone, the price still has to be quite far away from the gap % (70-80) target. The closer it already is to this target, the less meat there is to fade. Use those two variables as potential invalidation variables for the time variable to decide when it is best to be patient on covers or where to start instead of taking them.
Liquidity present at the time for establishing cover targets
Liquidity has a significant role in establishing the time-based cover targets if trader is short on fading ticker. The quicker the liquidity dries out, the more eager the trader should be to cover because chances are the ticker will be a very slow fader from thereon. On the other hand, the more liquid and higher volumes that ticker still trades by mid-day or later hours, the more patient the trader should be, as the deeper fade might still have a solid chance. This especially applies to weak cycles directly and for tickers that are already fading since first hour of market open.
Weak cycle conclusion
The intent of the explanations above are not to scare trader away from participating in the weak cycle, if that was your conclusion, please make sure to re-read the article as that is not the intent. There are specific advantages that weak cycle offers, if trader plays right on those they will make up for the negatives, at least to some extent. Too many traders are discouraged to trade in weak cycle, because the right conclusions or adaptations are not being made.
To sum it up, under a weak cycle, make sure to (for short-seller especially):
-Adjust your expectations lower on everything (entries, Rs, exits, etc).
-Lower your entries, be more eager to enter short
-Decrease the amount of potential recycles
-Lower your fade targets, deeper (be more patient)
-If long-biased, make sure to take profits earlier
-Pre-calculate the commission impact if there are specific trades you should avoid if the ticker has too weak a range and might not be worth trading it