The Reversal System

The Reversal System:
A 20-Year Case Study

Theory-Design-Implementation

© Martin A. Armstrong

Perhaps the most important discovery made here at Princeton was the simple fact that market price and economic movement is anything but random. This is a very powerful statement because you will be hard pressed to find many who would agree with us on this point. Everything taught in the field of economics begins with the assumption that activity is random. This lends itself to two key philosophical goals. The first is that since everything is random we should be able to shape the economy into whatever we choose. Hence, the creation of the Keynesian model of demand-side economics. The average consumer’s demand is manipulated through the raising and lowering of interest rates to affect the rich investors and businesses and ideally creating recession or expansion at will – or so they would like to believe. The second philosophical goal is that perpetual economic growth is theoretically possible. Unfortunately, this lofty goal is totally unrealistic. It assumes that, as in physics, a body in motion tends to stay in motion – all things will remain equal without external influences. But we all know that a body will not stay in motion when influenced bygravity, air density etc.. That law applies to a vacuum where no external force will change the immediate trend.

The Reversal System stands alone in the midst of conflicting economic theories. It is based upon certain principles in physics, which apply to everything around us. It also assumes that time is not a constant but that the theory of relativity applies. A number of people have tried to figure out exactly what this reversal formula might be. One such client fed every number generated for the last 10 years into a mainframe computer to no avail. The reason why no one has succeeded in figuring this mystery of ours out is simply because what you see depends upon your perspective. The formula itself changes by expanding and contracting relative to time. Therefore, the formula is never exactly the same at any given point. Yet the numbers it generates are carved in stone and forever remaining fixed – or so it would seem to the human observation.

Everything is indeed totally dependent upon your position of observation. Perhaps a simple example of one facet in this paradox of reality can be illustrated this way: Assume that you are in a house which only has windows in the front. Your view-port of the outside world would therefore be restricted to only that which stands directly before you. If some adversary were approaching from the rear, you would simply never see him coming.

If we look at things on a more global basis, we are adding windows to our house on the sides and rear. Now if anything takes place on any front, we are at least capable of observing it, provided we pay attention.

The Reversal System maps out various coordinates within price or statistical movement on many levels. Because the basic assumption is that all things will NOT remain equal instead of vice versa, the model is able to project precise points in price relative to time by constantly monitoring all levels and dimensions. Its view-port is the world and its accuracy is generated through the interactions of all component parts.

The model generated a Major Weekly Bearish Reversal in gold from the 1980 high at $280.50 basis spot. For years that number was published in our reports and discussed at seminars. Five years later in February 1985, the price low intraday in spot gold was precisely $280.50. Those who have run gold price movement through a computer trying to find the source of this number become lost. Since they are looking for price activity in gold and not its interaction with all other markets – they will never find it.

The complexity of market price movement is vast. On a simple level, charting futures contracts may provide the illusion that one is charting gold or whatever commodity in question. However, any chart is also including interest and carrying charges. Further complicating matters is the currency in which the prices are being quoted. Therefore, a chart of gold from the New York Comex is actually a combination of three primary interrelationships – gold, interest rates and the US dollar.

The uniqueness of the Reversal System and its accuracy is a result of the model actually taking into consideration every possible variable. Its projection is fixed because it has figured out time, price and interaction between relationships. The difficult part, even for us, is to try and figure out what fundamentals could cause such a projection five years from the date it is generated. In the human attempt to interpret what it means we are handicapped by our rational beliefs of what is and is not possible. If we have never witnessed a gold panic such as the case of 1869, then it is impossible to fundamentally take such an event into consideration. Hence, as the studies into forecasting have shown, judgemental forecasting is always dead last and totally useless for long-term planning. As humans, we cannot grasp a sense of all the infinite possibilities that lie on the horizon.

Physics teaches us one simple fact. If we throw a stone into a pond it will cause waves to ripple across the water in a circular fashion. Those waves will bounce off the shore and attempt to return. At the very instant the stone hits the water all subsequent events are already predetermined. Depending upon the force of impact, the end result will be the same. To the human observing this event, we do not know the velocity of the stone by mere sight. We therefore assume that all subsequent events may be similar, but not actually precise, which often leads to the false assumption of random movement.

The next 10-years of price activity have already been predetermined. At best, we might be able to hope that amplitude can be affected by our will but stopping the waves from hitting the shoreline is impossible without destroying the pond itself.

Let us consider the current situation in gold. There is a Monthly Bullish Reversal standing above the market at $570 in New York. The model indicates that a monthly closing above that level will cause new highs above those of 1980. At the precise moment whenever gold reaches $570, if we were to take every market and currency and equate them back to their relative position when gold reached $875 in 1980, we would find that gold is actually making a new high at $570. Because all the variables have changed, $570 is the equivalent position of 1980 relative to our time nearly 10 years later.

For the last 20 years, we have been studying this model in live situations as well as in historical research. The conclusion is without doubt rather shocking from the philosophical perspective. It appears that all price movement is, in fact, predetermined. Trends which evolve are never spontaneous and the root causes cannot be attributed to a single fundamental event at that particular moment. For example, the shift in capital flows which began in 1927 set the stage for capital shortages in Europe which led to drastically rising interest rates which in turn drove capital into the United States. The trends of the 1931 period during the Monetary Crisis of the Great Depression were set in motion at least 5 years prior. One can then look for the root causes of 1927 and find that the trend was set in motion by the events of 1919 and so on. In reality, every action causes a reaction as cause and effect ripples through the entire system exactly as a wave in a pond after the impact of a stone.

There will be many who take offense with our findings. They will undoubtedly argue that things are not predetermined and that man is capable of free will and thus the future can be altered. However, physics has proven that within chaos there is order and within order there is chaos. In the economic application this is also true. Our destiny may be predetermined as a whole, but as individuals we can choose free will and adopt a pattern of chaos within order thereby departing from the patterns generated by the whole. As individuals, not everyone will agree on the same point. The sheer lack of uniformity creates two trends within the whole, but the sum of the parts sets the course, which will be followed by the majority. In effect, this was also demonstrated by Adam Smith in his brilliant work published in 1776. The theory which Smith set forth, the Invisible Hand, is certainly an example of how conflicting components (individuals) in pursuit of their own self-interests, create the trend of the whole.

Another example of this economically can be witnessed at any period in time. While 1989 is the 7th year of economic expansion as a whole, depression has existed in Alaska, Alberta and Texas – just to mention a few places in North America. During the Great Depression of the 1930s, Texas was in the midst of its greatest boom. That is when oil was discovered and for Texas, at least, the Great Depression was a period of Great Prosperity. Not all sectors experience the same trend simultaneously. Therefore, there is indeed always chaos within order and order in the midst of chaos – which also provides the exception to every rule.

The general trend of the economy is labeled according the effects of the whole. Thus, the simple term “Great Depression” invokes images within our mind that everyone was equally affected. At Princeton, we have noticed patterns in our own volume of business. During recessions or periods of high volatility, the volume of our business rises significantly. Hence, following the ’87 stock market crash, demands for subscriptions, consultation and speaking engagements exploded. Periods of bullish trends do not produce huge demands. In many ways, our business trends are counter to those of economy in general. Perhaps this is true because in bull markets just about anyone can make money. But in times of confusion, very few know what to do.

Even though there will be many who disagree with the preliminary results of this case study at the 20 year mark, the success of the Reversal System itself stands as witness to our findings. If events in future economic price movement were totally unforeseeable sequences of random activity, then the number employed by our various services each day should not work. Since we can observe the effectiveness of the numbers in real day-to-day forecasting, clearly the trends of the future have been predetermined by prior events.

The question that remains to be answered is not whether this phenomenon is real, but how far-reaching into the future do our immediate decisions of today affect? Can the events of the future be reshaped with long-term planning?

The Reversal System conceptual design is therefore quite simple. Based upon physics, total random movement does not exist. Given this premise, the existence of specific pressure points in theory had to exist. For example, the velocity of wind within a storm distinguishes the difference between a tropical storm and a hurricane If water reaches a specific temperature it will boil. There are countless laws which apply in the physical surroundings, yet man seems to have such a high opinion of himself in assuming that he is totally random and not subject to definitive laws.

The Reversal System was born through this theory that specific points exist within economic or price movement. Something similar to the last straw, which broke the camel’s back – if enough pressure builds in either direction, eventually there must be one final point which, if exceeded or penetrated, signaled a change in trend. This was our scientific quest in searching for unemotional, non-human judgemental approaches to forecasting. The theory proved to be correct, and the last 20 years have been spent in studying this new phenomenon.

The case study which will eventually be written after 30 years of live forecasting and careful study of market interactions within interrelationships, undoubtedly will reshape the ability of the scientific approaches to forecasting in the future. Thus far, however, certain key fundamental understandings have emerged from our case study at the 20- year mark.

1) At major highs and lows in activity, it is normal to generate what we have called the “Double Reversal” which is the conjunction of two primary levels of short-, intermediate- or long-term on a single plane of observation. A plane of observation is defined as intraday, daily, weekly, monthly, quarterly and yearly activity. Beyond this exists the planes based upon time intervals of a decade, century and millennium. Of course planes exits well beyond this human level of relevant observation. Likewise, additional planes of observation exist within intraday activity defining it down into one minute intervals. The same phenomenon has been found to exist on all planes of observation which are subject to measurement standards.

2) The existence of a Triple and Quadruple Reversal has also been verified. We have not discussed these conjunctions due to their extreme rare occurrence. The probability studies that have been conducted illustrate this rare phenomenon. The “Double Reversal” on a weekly plane in live observation of gold occurred in 1971,1975,1976,1980,1982,1983 and 1985. In the case of 1976 and 1985, two sets of these “Double Reversals” were generated – one on the bearish and the other on the bullish directional models. The “Triple Reversal” occurred only once in 1976 and the “Quadruple Reversal” has occurred only once thus far during this century in 1929 within historical research observations.

3) The Reversal point itself appears to have no end in time space insofar as its relevant life-cycle. For example, the Major Weekly Bearish Reversal generated from the 1980 high in gold was $280.50. Five years and one month later we found gold bottom precisely at $280.50 in February 1985. This tends to suggest that the formula itself succeeds in cutting through the problems of observation and dimension solving far more complex mathematical situations of interrelationships between market price movements which the human mind is not quite ready to understand.

4) The life-cycle of a number is not subject to definitive duration nor does it appear to be an empirical frequency. For example, taking a given major turning point, the time required to pass where the Reversal point will eventually come into play with market activity is not consistent. This process has taken as little as two months as in the case of the stock market crash in 1987 and five years in the case of gold from 1980.

5) Each market reacts in a slightly different manner to the Reversals themselves. The metals, currencies and bonds have a high degree of precision. Market movements will bounce precisely on these specific Reversal points. Stocks, on the other hand, will respond as precise only on an individual basis. When employing the Reversal Points in something such as the S&P 500, we find that absolute precision is rare. For example, the precise support given by the Reversal System for the ’87 crash was 18100 on the nearest futures. The market stopped at 18130. This tends to suggest that since the S&P is introducing another series of 500 variables into the equation, that absolute precision begins to suffer. Whereas absolute precision is the norm in the cases of gold and many other less complex market infrastructures.

These are just a few of the conclusions from our 20-year case study. There are many other observations, which are extremely interesting and serve as vital evidence to support the entire hypothesis. Nevertheless, the most important aspect of this study remains unanswered as yet. Just how far in the future do today’s decisions affect?