With the Dow rallying since February 8, 2010, more people have been willing to dip their toes back in the equities markets. We often get the question: "Do wave patterns work with individual stocks the same as they do in aggregated stock indexes?" The answer is "Yes, but less frequently and less clearly." After all, the Wave Principle is based on herding, so the larger the herd that trades, the easier it is to see the patterns. That means that the market averages, like the Dow, the Nasdaq and the S& P 500, have the clearest wave patterns. Remember, we see the recent market move as a bear-market rally, so you may want to think about doing something other than buying and holding. In this excerpt from Prechter's Perspective, Bob Prechter explains when it's worth acting on the wave pattern in an individual stock.
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Question: You've said that individual stocks often reflect the Wave Principle too fuzzily to have great practical value. Why is the analyst less likely to have success trying to apply wave counts to a given stock?
Bob Prechter: The reason the Wave Principle is so clear in aggregate stock price indexes is that the Wave Principle is a reflection of changes in mass psychology. The market averages show you whether people involved in the market as a whole are putting their money in or taking it out. When they are more optimistic about the future, they tend to put more in. When they are more pessimistic, they tend to take it out.
Question: And with individual stocks?
Bob Prechter: The same kind of behavior does show up in many individual stocks, but you have to act only on the clearest patterns, which indicate that crowd emotion is in charge. When you are dealing with an individual stock, there may be many reasons to buy or sell a particular issue, e.g., what the competition is doing, what foreigners are doing with similar products, government policy, whether the CEO is having family problems, or whether the brain behind the company has left. There are a lot of specific and individual reasons why a single stock will be going up or down on a particular day, week or month. So, if you try to follow an individual stock, it won't necessarily trace out patterns that perfectly reflect the Wave Principle.
Question: Obviously, though, if the averages are headed lower, a lot of individual stocks are going down.
Bob Prechter: Yes. Despite the important distinction I have just made, many stocks tend to move more or less in harmony with the general market. An old adage says that 75% of all stocks move up with a bull market, and 90% of all stocks move down with a bear market.
Question: But individual stocks do trace out their own patterns. Under what circumstances is it worthwhile to act on the wave pattern of a stock?
Bob Prechter: The best approach seems to be to avoid trying to analyze each issue on an Elliott basis unless a clear, unmistakable wave pattern unfolds before your eyes and commands attention. Decisive action is best taken only then.
Question: Even if your count for the overall market is headed in the opposite direction?
Bob Prechter: Regardless of the wave count for the market as a whole.
Question: So, a stock can go its own way and act individualistically. Couldn't a couple of maverick performers upset the averages and throw the long-term wave count out of whack?
Bob Prechter: No. The unique circumstances surrounding each company cancel each other out, leaving as residue a mirror of the mass mind alone. Therefore, the progress of general business activity is well reflected by the Wave Principle, while each individual area of activity has its own essence, its own life expectancy, and a set of forces that may relate to it alone. After all, many companies go out of business. That's hardly an Elliott wave, which continues progressing, is it?
Question: I guess you could say the same thing about an individual investor vs. the group.
Bob Prechter: Absolutely. An individual's capacity to reason allows that person to understand the Wave Principle, and free will gives that person the capacity to alter his or her own actions so as to avoid the pressures of the crowd and even take advantage of the opportunities presented. But that person's individual action will not change the direction of the group, just as one falling stock will not change a bull market, nor a rising stock a bear market.
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