Okay, so I did my homework regarding Elliot Wave Theory. Before I did my homework, I understood the basic premise, but after doing some reading, I feel I can speak to the concept with some intelligence …
First things first, though. Let’s all get on the same page.
The Elliott Wave Principle is a form of technical analysis that investors use to forecast trends in the financial markets by identifying extremes in investor psychology … It reveals that mass psychology swings from pessimism to optimism and back in a natural sequence, creating specific and measurable patterns (waves) … If you can identify repeating patterns in prices, and figure out where we are in those repeating patterns today, you can predict where we are going … Elliott Wave Principle measures investor psychology, which is the real engine behind the stock markets. Using the Elliott Wave Principle is an exercise in probability.
Ralph Nelson Elliott (1871–1948) developed the concept in the 1930s. He proposed that market prices unfold in specific patterns, which practitioners today call Elliott waves, or simply waves. Elliott said that “because man is subject to rhythmical procedure, calculations having to do with his activities can be projected far into the future with a justification and certainty heretofore unattainable.”
When I was listening to the interview with Robert Prechter (see yesterday’s column), his depth of belief in the predictive power of the Elliot Wave Principle struck me as devout. In a religious context, Prechter would be considered a prophet. Now, after reading up on the history of the “theory,” I understand why he and others are such devotees, but what I don’t understand is why the followers believe the principle alone can precisely predict our long-term economic future.
In the interview, Prechter consistently used facts to analyze both the current state of economic affairs and the probability of where the economy would go. Although I disagree with his broad conclusion, I respected his analysis, and I have adjusted my own thinking based on what he had to say. Given this, I ask the same question but in a different frame – could one use the Elliot Wave Principle to project a future outcome without using the facts as we know them? Could one sit in a room isolated from any information and only utilizing Elliot “waves” actually predict news headlines years in advance, as Prechter claims in his interview?
Admittedly, I have not studied the Elliot Wave Principle deeply enough to claim I understand it thoroughly, or to pass judgment on it, but from the information I have gathered, I can say I agree with the notion that natural cycles exist, that human behavior, in general, moves in identifiable patterns, and that “… the Elliott Wave Principle is an exercise in probability.” Probability, not certainty, is the key word in this discussion because one thing we all know for sure about human behavior is that in the abstract and general it is predictable, but in the concrete and specific, it is far from predictable. Once again, variables define outcomes, and in both the market and the economy, the variables are many and the psychology (sentiment) of the participants is one important variable, but it is not the only variable. What if, for example, in a cycle of optimism, some whacko terrorist releases a radioactive, dirty bomb in London or New York, two financial centers of global importance? This would certainly change the “mood” of everyone, don’t ya think?
Tomorrow, I will have just a bit more on this. One of the many intelligent readers of this column sent me an Elliot Wave forex prediction (24-hour timeframe) that will either be true, or it will not. We will see …
Trade in the day; invest in your life …
