The Truth About Elliott Wave Analysis

Last evening, one of my members forwarded me a public post made by another “analyst” about Elliott Wave analysis, which seemed to be supported by his novice acolytes.  And, yes, that perspective suggested that Elliott Wave is “useless as a tool for market analysis.”

So, please allow me to deal with the substance of the issue at hand, and that is the accuracy and usefulness of Elliott Wave analysis.

As I have cited many times before, Mr. Alan Greenspan, a former Chairman of the Federal Reserve, noted that markets are driven by “human psychology” and “waves of optimism and pessimism.” Ultimately, as Mr. Greenspan correctly recognized, it is social mood, which oscillates between optimism and pessimism, that will move markets. This is why news does not cause a change in the trend of the market, unless that trend is already set to change. In fact, have you ever wondered why a market will continue to go up after the announcement of bad news, or down after the announcement of good news?  Now maybe you can understand why the stock market has continued higher despite all the bad news being thrown at it.

This is why any investor who is able to rise above news and emotion, and identify the prevailing social moods and trends, will have a significant advantage over other investors.  But, how does one accurately and consistently track these changes in social mood?

Ralph Nelson Elliott postulated that public sentiment and mass psychology moves in 5 waves within a primary trend, and 3 waves in a counter-trend. Once a 5 wave move in public sentiment is completed, then it is time for the subconscious sentiment of the public to shift in the opposite direction, which is simply a natural cause of events in the human psyche, and not the operative effect from some form of “news.”

This mass form of progression and regression seems to be hard wired deep within the psyche all living creatures.   This is what we have come to know today as the “herding principle,” and the herd seems to turn at Fibonacci ratios, as supported by many modern studies. 

Humans are hard wired for herding within their basal ganglia and limbic system within their brain, which is a biological response they share with all animals. In fact, in a study performed by Dr. Joseph Ledoux, a psychologist at the Center for Neural Science at NYU, he noted that emotion and the reaction caused by such emotion occur independent and prior to, the ability of the brain to reason.

In a paper entitled “Large Financial Crashes,” published in 1997 in Physica A., a publication of the European Physical Society, the authors, within their conclusions, present a nice summation for the overall herding phenomena within financial markets:

Stock markets are fascinating structures with analogies to what is arguably the most complex dynamical system found in natural sciences, i.e., the human mind. Instead of the usual interpretation of the Efficient Market Hypothesis in which traders extract and incorporate consciously (by their action) all information contained in market prices, we propose that the market as a whole can exhibit an “emergent” behavior not shared by any of its constituents. In other words, we have in mind the process of the emergence of intelligent behavior at a macroscopic scale that individuals at the microscopic scales have no idea of. This process has been discussed in biology for instance in the animal populations such as ant colonies or in connection with the emergence of consciousness.

In fact, one commenter to one of my articles on Seeking Alpha made the following astute point regarding how news affects these subconscious herding trends:

Compare the market to a stream of ants marching by in, generally, a single direction. Run a stick across their path and there will be some momentary confusion and reaction to the direct stimuli but very soon afterwards the original parade of ants continues and the stimulus is forgotten.

So, based upon much research, it does seem that the market may be considered to be on a path that is determined by a mass form of herding that is given direction by social mood. It sure does explain the oft asked question of why markets go up when bad news is announced or vice versa. It also takes out all the guess work in attempting to determine the next “news event” that may move markets.

However, in order to perform an appropriate Elliott Wave analysis on a stock or a market, there is a significant amount of detail work which needs to be performed  Since markets are fractal in nature, any appropriately supported Elliott Wave analysis must conform all degrees of a trend to an appropriate Elliott Wave structure.   Moreover, we have developed a method which we call Fibonacci Pinball, which takes much of the subjective analysis out of a standard Elliott Wave form, and provides a more objective analysis methodology to the Elliott Wave form. But, each wave degree must conform to these objective standards to be an accurate Elliott Wave count upon which one may rely.

But, most of what is presented as Elliott Wave analysis is really no more than what I call “wave slapping.”  That means that most people who present what they term Elliott Wave analysis is nothing more than “slapping” numbers and letters onto a chart based upon the “look” of the chart.  That will rarely provide an accurate analysis of market sentiment, and when most of the projections based upon this type of “analysis” fail, one can now understand why.

Many also take issue with the fact that Elliott Wave analysis suggests you maintain both a primary analysis, as well as an alternative analysis.  Those that take issue with this suggest that it is akin to saying the market is either going to go up or go down. However, this simply further brings to light the foolishness of those who make such claims.  You see, financial markets are non-linear in nature.  For this reason, one must adopt a methodology, such as Elliott Wave analysis, which adapts to the non-linear nature of the market.   

While you should follow your primary analysis, should the market break a support or resistance which tells you that your primary analysis is not correct, you then have a back-up plan which you can immediately place into operation.  And, quite often, even the alternative may be pointing in the same direction as the primary, but simply within a different pattern.  

For those that truly understand the nature of financial markets, this is actually one of the major strengths of using Elliott Wave analysis, rather than a weakness, as those who do not understand it claim.  Does any army go to war without a contingency plan?  In fact, if this analyst I noted above had used Elliott Wave analysis for his purchase of a leveraged ETF for a long-term hold, I am quite certain he would not have held it for a 70%+ draw down.

This brings me to another point.  Within this foolish post made by this “analyst” I mentioned above, along with his acolytes, they have clearly provided their definitive opinion that Elliott Wave is “useless”  But, my question to them is how much study have they put into Elliott Wave analysis to be able to provide us with a truly reliable opinion?

You see, most of these “opinions” are made by those who have no real understanding of how Elliott Wave analysis is supposed to be applied, or why it even works.  And, the reason I have noted that their “opinions” are foolish is because only a fool would opine about that which they truly do not understand. As Ben Franklin noted:

“Any fool can criticize, condemn and complain and most fools do.”

Consider how much weight you would give to an opinion of someone who has no knowledge about biology, who then claims that surgery is simply useless?   You would summarily dismiss this person as a fool and provide no weight at all to his opinion.

Then why would you consider the opinion of someone who knows nothing about any methodology upon which he is providing an opinion?  Rather, anyone who would opine about that which they do not have a deep understanding is nothing more than a fool and their opinion should be summarily dismissed.

Lastly, as far as how accurate one can be using Elliott Wave analysis, please allow me to give you just a few of the major market calls we have made over the last six years since we have been open at Elliottwavetrader.net:

We correctly called for gold to top within $6 of its actual high in 2011.

We correctly called for the low in the metals market at the end of 2015.  In fact, our metals broker wrote this about our purchases at the time:

“Your timing on buying the dips is uncanny Avi! People should be aware of this if you don't mind. . . I can attest to your accuracy on actually buying both gold and silver from us as close to the bottom as one could. With gold you called it to the letter and your limit order which was placed well in advance executed perfectly. The silver limit orders were within a tight range of the lows as well.”

Doug Eberhardt of Buygoldandsilversafely.com

We correctly called for a multi-year rally in the DXY back in July of 2011 when it was in the 74 region, when most other analysts were calling for the “death to the dollar” at that time.   In fact, our first major target was the 103.53 region, the 1.618 extension of waves 1 and 2 (an Elliott Wave projection).  And, as we now know, the market struck a high of 103.82 at the start of 2017 before we dropped strongly off that region since that time.

Back at the end of 2015, we called for the SPX to drop from the 2100 region down to the 1800 region, which would then set up a “global melt up” wherein the SPX would reach a target of at least the 2537-2611 region.  Again, for those that remember the early 2016 time-frame, most analysts were quite bearish at the time, expecting a market crash. Meanwhile, we were preparing for the 700+ point market rally we were correctly expecting

Back on November 4^th, a few days before the election, we were calling for the market to bottom out in the near term, and continue its rally towards the 2500 region into 2017 “no matter who wins the election.”   As we all may remember, most market participants were quite certain that the bull market would come to an end if Donald Trump would become the next President of the United States.  So, when Mr. Trump won the election, and the market began its strong rally to the 2500 region, it again substantiated our analysis, especially since it was the exact opposite of what most market participants believed at the time.

While these are just a handful of the many correct market calls we have made in the 6 years we have been open at Elliottwavetrader.net, I think it provides substantial proof as to the “usefulness” of Elliott Wave analysis, as applied through our Fibonacci Pinball methodology.

So, I would implore anyone who is reading my words to consider adopting a methodology which tracks what truly moves markets – market sentiment.  And, Elliott Wave analysis is truly the best methodology I have ever come across which accurately tracks market sentiment.