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Technical and cycle analysis is a way to try to predict trends in the financial markets, by identifying cycles that repeat themselves.
Technical analysts believe that these market cycles exist, and there are two primary reasons given as to why the cycles form:
1) Fundamentals: cycles reflect lags that affect shifts in supply and demand.
In basic manufacturing terms, when prices rise, it pays for the manufacturer to increase production.
However, as there is a lag (new plants need to be build etc) to increase supply, the increased supply will hit the market at the same time, which leads to a fall in price, leading to cycles in the marketplace.
2) Psychological: cycles reflect the psychological response of traders to price swings.
The market move in one direction for a period of time. The longer the trend, the more anxious traders become to cash their positions and positioning their trades for a movement in the opposite direction.
Many traders are willing to cash their positions on the first sign of weakness on the trend, increasing the movement in the opposite direction, which leads to cycles.
One of the first ones to use cycles based technical analysis to make money was the famous Rothschild family in Europe, which used cycle analysis on the British interest rates. Their system included three cycles, including a 40 month cycle.
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