What makes Elliott wave analysis so interesting is that, although it's technical analysis based on price charts, it's not overly technical. At heart, it describes changes in a large group of people's ideas about their investments. In other words, it's about mass psychology. And because the Wave Principle is based on psychology, it works best in markets that are affected most by mass psychology -- think stock averages, precious metals, interest rates, currencies and commodities. Read the reasons why in this question-and-answer interview with Bob Prechter.
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Q.: What does the fact that the stock market is patterned mean?
Bob Prechter: My addition to the theory of the Wave Principle is that the stock market is a direct reflection of mass psychological change, which in turn shapes events….
Q.: I'm not sure I see. Is human psychological response the Wave Principle's causal agent?
Bob Prechter: Not exactly. My opinion is more radical than that. Market psychology is not responsive. It is not the result of events out side the market. Collective psychology is impulsive, self-generating, self-sustaining and self-reversing. The dynamics of social psychology operated by the same dynamics over and over again, regardless of different attendant historical or cultural specifics. Events that make history are the result of the mass mental states that take time to develop This is the only possible explanation for the constancy of structure and consistency of pattern that markets reveal. Unconscious minds are participating, I would say, as opposed to responding.
The fact that markets follow the Wave Principle, as opposed to some other law, provides the added insight that social mood and its result, history, follow the same law of pattern found throughout nature in other processes of growth and decay. That is what makes the subject more engaging than, say, the put/call ratio.
How To Keep Up With a Bull Move in a Bear Market. When financial markets turn up in a bear market, it's tempting to think that a new bull market has started. Elliott wave analysis tells us, though, that the latest moves are a bear-market rally. Rather than being swept away by wishful thinking, take a moment to subscribe to the latest Elliott Wave Financial Forecast. Read more here.
Q.: You said "markets" and not just "the market." Do you apply it to a lot of different trading arenas?
Bob Prechter: Yes. And while this is another of the properties that make the Wave Principle attractive, it can also hurt the reputation of the theory if it is applied where it doesn't belong.
Q.: Which markets can you apply the Wave Principle to?
Bob Prechter: The
Wave Principle works best with markets that are the most heavily influenced by mass psychology. An individual stock may have a lot of reasons for going up or down according to the various investors involved. When you're discussing the entire market, or an average of blue-chip stocks, the bottom line – after all the individual decisions about whether to buy or sell stock A, B or C – is the answer to the question, "As a whole, are people putting money into or taking money out of the stock market?" The answer to that question depends upon their collective emotional state.
Gold in particular follows the Wave Principle impeccably, at least in a world of fiat paper currencies. Gold is a wonderful reflector of the Wave Principle because unlike, say, pork bellies, it is traded by people around the globe, so the prime mover is the psychology of human beings at the most shared and basic level. I think that's one reason the wave structure has been so perfect. If you trade gold or silver, think about using Elliott. It will keep you on track much of the time.
Q.: I thought gold went up and down with inflation.
Bob Prechter: That's not quite it. Gold reflects a psychological orientation to rates of inflation as they relate to investor expectations, which is quite a different thing.
Q.: But there is some connection?
Bob Prechter: Sure, but understand what it is. Gold's price relative to currencies certainly reflects the inflationary and deflationary forces in the various states' money supplies, which is made up mostly of promissory notes called bonds, notes, bills and currency. Now, most people respond that this observation proves that markets are mechanical responses, which is utterly false. After all, inflation and deflation are at root primarily psychological phenomena as well. They derive mostly from the expansion and contraction of credit, and the other side of the transaction, debt, which is based upon the waxing and waning of aggregate confidence in the financial future. So it still comes back to social psychology, which is the driving force behind change in the rates of debt accumulations and dissolution, and thus of inflation and deflation. For that reason, interest rates reflect the Wave Principle almost as well as gold.
Q.: But don't interest rates have the tremendous effect of and control by the Federal Reserve?
Bob Prechter: When I first started following interest rates, I figured, I'm not going to see wave structures in here, because to a great degree, they are manipulated." I started in 1979, and that was two years into Jimmy Carter's administration. Chaos reigned in the bond market, and upon examination, it was unbelievable how closely the price of money was following typical Elliott wave structures. When the anchor of gold was kicked away by Nixon in the early 1970s, the bond market became a boiling pit of mass psychology. It has been a mixing bowl of confidence, anxiety, hope and fear, shifting back and forth as the players try to guess what the government will do and the government tries to guess what the voters want. That is a terrific background for clear Elliott wave patterns. As for the Fed, today the bond market is bigger than the Fed. The Fed cannot do whatever it wants anymore. If it acts, the market will make a judgment, and depending upon the psychology of bond investors, they can support, neutralize and reverse whatever the Fed attempts to do to affect the money supply. The market is in charge, and the Fed knows it.
Q.: O.K., so the Wave Principle applies to the stock averages, precious metals and interest rates.
Bob Prechter: And currencies, many commodities, and even to hot stocks that reveal powerful psychological forces at work.
How To Keep Up With a Bull Move in a Bear Market. When financial markets turn up in a bear market, it's tempting to think that a new bull market has started. Elliott wave analysis tells us, though, that the latest moves are a
bear-market rally. Rather than being swept away by wishful thinking, take a moment to subscribe to the latest
Elliott Wave Financial Forecast.
Read more here.