In the 1930s, Ralph Nelson Elliott, a corporate accountant by profession, studied price movements in the financial markets and observed that certain patterns repeat themselves. He offered proof of his discovery by making astonishingly accurate stock market forecasts. What appears random and unrelated, Elliott said, will actually trace out a recognizable pattern once you learn what to look for. Elliott called his discovery "The Elliott Wave Principle," and its implications were huge. He had identified the common link that drives the trends in human affairs, from financial markets to fashion, from politics to popular culture.
Robert Prechter, Jr., president of Elliott Wave International, resurrected the Wave Principle from near obscurity in 1976 when he discovered the complete body of R.N. Elliott's work in the New York Library. Robert Prechter, Jr. and A.J. Frost published Elliott Wave Principle in 1978. The book received enthusiastic reviews and became a Wall Street bestseller. In Elliott Wave Principle, Prechter and Frost's forecast called for a roaring bull market in the 1980s, to be followed by a record bear market. Needless to say, knowledge of the Wave Principle among private and professional investors grew dramatically in the 1980s.
When investors and traders first discover the Elliott Wave Principle, there are several reactions:
-Disbelief – that markets are patterned and largely predictable by technical analysis alone
-Joyous 'irrational exuberance' – at having found a 'crystal ball' to foretell the future
-And finally the correct, and useful response – 'Wow, here is a valuable new tool I should learn to use.'
Just like any system or structure found in nature, the closer you look at wave patterns, the more structured complexity you see. It is structured, because nature’s patterns build on themselves, creating similar forms at progressively larger sizes. You can see these fractal patterns in botany, geography, physiology, and the things humans create, like roads, residential subdivisions… and – as recent discoveries have confirmed – in market prices.
Natural systems, including Elliott wave patterns in market charts, 'grow' through time, and their forms are defined by interruptions to that growth.
Here's what is meant by that. When your hands formed in the womb, they first looked like round paddles growing equally in all directions. Then, in the places between your fingers, cells ceased growing or died, and growth was directed to the five digits. This structured progress and regress is essential to all forms of growth. That this 'punctuated growth' appears in market data is only natural – as Robert Prechter, Jr., the world's foremost Elliott wave expert and president of Elliott Wave International, says, 'Everything that thrives must have setbacks.'
Basic Elliott Wave Pattern.
The first step in Elliott wave analysis is identifying patterns in market prices. At their core, wave patterns are simple; there are only two of them: 'impulse waves,' and 'corrective waves.'
Impulse waves are composed of five sub-waves and move in the same direction as the trend of the next larger size (labeled as 1, 2, 3, 4, 5). Impulse waves are called so because they powerfully impel the market.
A corrective wave follows, composed of three sub-waves, and it moves against the trend of the next larger size (labeled as a, b, c). Corrective waves accomplish only a partial retracement, or 'correction,' of the progress achieved by any preceding impulse wave.
As the figure above shows, one complete Elliott wave consists of eight waves and two phases: five-wave impulse phase, whose sub-waves are denoted by numbers, and the three-wave corrective phase, whose sub-waves are denoted by letters.
What R.N. Elliott set out to describe using the Elliott Wave Principle was how the market actually behaves. There are a number of specific variations on the underlying theme, which Elliott meticulously described and illustrated. He also noted the important fact that each pattern has identifiable requirements as well as tendencies. From these observations, he was able to formulate numerous rules and guidelines for proper wave identification. A thorough knowledge of such details is necessary to understand what the markets can do, and at least as important, what it does not do.
You have only just begun to learn the power and complexity of the Elliott Wave Principle. So, don't let your Elliott wave education end here. Join Elliott Wave International's free Club EWI and access the Basic Tutorial: 10 lessons on The Elliott Wave Principle and learn how to use this valuable tool in your own trading and investing.
- Are We Near a Low in the Stock Decline? http://budurl.com/sug2 #
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- Our social mood is changing - a reflection of #deflation http://budurl.com/yt22 #
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- @cartridgesplus During #deflation cash is king? http://budurl.com/q9hb #
Top news in the US this morning is Obama's response to the carmakers slowness to restructure. Americas mood is turning, from hope that the Government can bailout the economy, to distaste and anger at the behavior of those receiving Government money.
Last month there was the scandal of Wells Fargo accepting bailout money then throwing a lavish party with Sheyl Crow entertaining and guests receiving Tiffany gift bags. Then there was the AIG bonuses scandal, for none other than their Financial Services Division who got the giant into the mess in the first place. Now it's the carmakers turn.
When this financial crisis reached high enough for the slow cumbersome Government to become involved, the public mood was different. The public reasoned the banking and financial system needed help or we would all sink together, and bailouts were seen in a more positive light. Now the mood has changed.
We have been in a downwards cycle for a while now, and this cycle is made up of three main parts. The Elliott Wave Principle has three waves down, with A being down, B an upwards retracement and C the main wave downwards. Each part of this sequence has its own personality.
This mathematical and practical principle follows social mood, and different parts of waves have different personalities. That personality can be measured by social mood, in this case tolerance for perceived excesses of yesterdays heroes as they become todays villains.
This insight is more than just an interesting intellectual exercise. 'Waves' properties not only forewarn what to expect in the next sequence but at times can help determine the market's present location in the progression of waves' from chapter 2, Elliott Wave Principle by Frost and Prechter.
By reading the current social mood and studying stock market charts, we can ascertain where we are in the overall picture. Then we can predict what happens next, not only to social mood but to the markets that represent them. It's a very powerful combination, and fascinating to watch unfold.
March 25, 2009
The following is excerpted from Robert Prechter’s Independent Investor eBook. The 75-page eBook is a compilation of some of the New York Times bestselling author’s writings that challenge conventional financial market assumptions. Visit Elliott Wave International to download the eBook, free.
By Robert Prechter, CMT
The natural tendency of people to apply physics to finance explains why successful traders are so rare and why they are so immensely rewarded for their skills. There is no such thing as a 'born trader' because people are born — or learn very early — to respect the laws of physics. This respect is so strong that they apply these laws even in inappropriate situations. Most people who follow the market closely act as if the market is a physical force aimed at their heads. Buying during rallies and selling during declines is akin to ducking when a rock is hurtling toward you.
Successful traders learn to do something that almost no one else can do. They sell near the emotional extreme of a rally and buy near the emotional extreme of a decline. The mental discipline that a successful trader shows in buying low and selling high is akin to that of a person who sees a rock thrown at his head and refuses to duck. He thinks, I’m betting that the rock will veer away at the last moment, of its own accord. In this endeavor, he must ignore the laws of physics to which his mind naturally defaults. In the physical world, this would be insane behavior; in finance, it makes him rich.
Unfortunately, sometimes the rock does not veer. It hits the trader in the head. All he has to rely upon is percentages. He knows from long study that most of the time, the rock coming at him will veer away, but he also must take the consequences when it doesn’t. The emotional fortitude required to stand in the way of a hurtling stone when you might get hurt is immense, and few people possess it. It is, of course, a great paradox that people who can’t perform this feat get hurt over and over in financial markets and endure a serious stoning, sometimes to death. Many great truths about life are paradoxical, and so is this one.
For more information, download Robert Prechter’s free Independent Investor eBook. The 75-page resource teaches investors to think independently by challenging conventional financial market assumptions.
Robert Prechter, Certified Market Technician, is the founder and CEO of Elliott Wave International author of Wall Street best-sellers Conquer the Crash and Elliott Wave Principle and editor of The Elliott Wave Theorist monthly market letter since 1979.
So far the American Government has pledged $9.7 Trillion (Bloomberg.com) to $11.5 Trillion (bizzia.com), depending on where you read it. It's more than the US spent on WWII (adjusted for inflation). And so far, the bailout requests just keep on coming.
Is it working? Is the economy recovering? Surely with that large a transfer of money from taxpayers to big business there should be an end to the bad news? Have the layoffs abated? Have the foreclosures slowed?
Why is this massive bailout not working? Why can the Fed not prevent deflation and depression? For a comprehensive answer to these questions you will need to read Robert Prechter's book Conquer the Crash, chapter 13 titled 'Can the Fed Stop Deflation?'
The US is in a downward deflationary spiral that is going to get worse before it finds a bottom. To understand why this is so you need to understand the Elliot Wave Principle. Human behavior and the economy move in waves, at its most basic three waves up and two waves down. Currently the US is on a downward leg. Each portion of the wave cycle has its own characteristics, and the current wave cycle calls for backlash characteristics.
If you go to Google news you can read about the growing public anger at these massive bailouts. If you read the comments below the articles, you get an idea of the depth of anger people are developing towards government attempts to restart the economy.
Before this is all over we will see fallen heroes (such as Warren Buffet, see post below), and an end to major institutions charged with mismanaging our affairs. This will be a result of the backlash, starting with a backlash on bailouts.
If you want to keep up to date with analysis and predictions of what's happening with the global economic crisis and the social ramifications, you can get this three times a week with the Elliott Wave Short Term Update. At the very least it makes for great party conversation starters, but it's surely better to stay one step ahead of the herd and use timely information to make money during these difficult times.
It's party time in corporate America still apparently. With AIG receiving more than USD$170 billion in government bailout money, it then gave more than USD$165 million in bonuses to senior executives. The rub for the American public is the bonuses were not just to any senior executives at AIG. This USD$165 million in bonuses was to the Financial Services Division, the very people at AIG whose decisions got the company into this mess in the first place.
One interesting response from AIG was that if they did not give the bonuses to those executives, then they may lose some valuable people. Seriously. Apparently the people who engineered a massive loss that is yet to find a bottom, requiring taxpayers to pour money in to keep the company afloat, are valuable employees. Or are we to believe that the people whose decisions led to AIG's financial mess have all mysteriously left the company and the current team in Financial Services are new guys there to clean up the mess? Really?
Another point of view on the 'valuable employee' slant is that anyone with experience at AIG Financial Services Division on their CV is going to find it tough to land another position. I mean, would you employ them? Even to balance your checkbook?
The good news today is that 15 out of the top 20 bonus recipients have agreed to return their bonuses, all of it. However, the public will be asking, what are the other 5 doing? And what about the other below top 20 recipients? Apparently some of them are refusing to return the money.
When we are in a period of deflation social mood turns sour. The executives at AIG are squarely in the firing line of public opinion, and there's not much they can do to avoid it. This whole scenario is playing out exactly as predicted in The Elliott Wave Theorist, October 2003.
How can Elliott Wave Theorist be so accurate? It relies on social and economic cycles. Currently we are in a downwards cycle, a pessimistic mood. I predict Warren Buffet's reputation will come in for a hammering soon, as the richest man in the world he is subject to being 'vilified' (EW Theorist, October 2003).
If you want to know what else is in store for our future social events, check out Elliott Wave International, they have a wide variety of financial, economic and social commentary and predictions.