Whether you are an EWI subscriber, a member of our free Club EWI, or just someone who is only beginning to discover this website, you know that our views on what moves the financial markets are very different from those in the mainstream financial media.
The unconventional economic and social perspectives we at EWI bring to you are based on the Elliott Wave Principle.* Its main hypothesis -- and the hardest one to swallow -- is that mass investor behavior is not random, but patterned. And since it's patterned, it is also predictable.
This assertion goes against most economic theories, which claim precisely the opposite: that markets are random and unpredictable. The dominant theory among these is the Efficient Market Hypothesis. First proposed in the 1960s, it states that the price of a market security is always “efficient” -- i.e., correct -- because investors are all rational beings that make decisions upon rational considerations. Therefore, prices simply can't ever be too high or too low -- they are always “just right.”
You can see why this view of the financial markets is so appealing. Every person considers him or herself a rational individual who makes decisions independently, free of any outside emotional influences. No one wants to admit that -- yes, $700 for one share of Google, or $1200 for an ounce of gold, or $1.2 million for a one-bedroom Miami condo may be too high, but... hey, everybody’s buying them, so it must be OK.
And under the Efficient Market Hypothesis, the price is never “too high.” It just can’t be; no such thing as a "bubble." Which is a very comforting thought.
Elliott Wave Principle, on the other hand, says that market prices are inefficient, because they are a function of social mood -- not reason. Individuals can be quite rational, but groups and crowds are not; they are emotional. In the financial markets -- which are nothing but large crowds of investors buying and selling market securities -- mass emotions swing from one extreme to the other. When millions of investors watch the price of the same security bounce around their screens, collective psychology takes over individuals’ rational impulses. That’s why most investors simply end up copying the actions of others, regardless of whether or not it’s rational to do so.
This cartoon has been around for years, but it illustrates this point perfectly (KAL, Baltimore Sun):
First Trader: “I’ve got a stock here that could really excel.”
Crowd: “Really excel?” – “Excel?” – “Sell?” – “Sell, sell, sell!”
Second Trader: “This is madness! I can’t take this any more! Good bye!”
Crowd: “Good bye?” – “Bye?” – “Buy, buy, buy!“
Fortunately for those of us familiar with the Wave Principle, shifts in social mood occur in recognizable patterns. And once you learn to spot them in the markets, you can also learn to forecast them -- just like Ralph Nelson Elliott first did some 80 years ago.
* We owe the remarkable discovery of the Elliott Wave Principle to Ralph Nelson Elliott, born on July 28, 1871 in Marysville, Kansas. Bedridden at the age of 58, Elliott needed something to occupy his mind, and he turned his full attention to studying the behavior of the stock market. Investigating the possibility of form in the marketplace, Elliott examined yearly, monthly, weekly, daily, hourly and half-hourly charts of the various indexes covering 75 years of stock market behavior. In May 1934, Elliott's observations of stock market behavior began coming together into a general set of principles that applied to all degrees of wave movement in the stock price averages. Today's scientific term for a large part of Elliott's observation about markets is that they are "fractal," coming under the umbrella of chaos science, although he went further in actually describing the component patterns and how they linked together.
As a result of Elliott’s pioneering research, today, thousands of institutional portfolio managers, traders and private investors use the Wave Principle in their daily investment decision-making. Ralph Elliott undoubtedly would be gratified to see it.