Is the Ellott Wave Analysis Predictive?

Is the Elliott Wave Analysis Predictive?


I have been an Elliott wave enthusiast since 1995, when I first read the book “At the Crest of the Tidal Wave” by Robert Prechter. Back then, Prechter was forecasting a bear market to last decades. Although scientifically, it made sense to me that there would be an order to the universe — my training is in the biological science, I am a Veterinary Pathologist — it made little sense to me that Prechter would go back to the 1400’s to look for the origin of the Dow Jones Industrial average, when the Dow had only been around as an index since the 1890’s. Nevertheless, at the time I thought that understanding the Elliott wave theory was a task worth the effort.

If you search in the web for Elliott wave forecasts going forward, you might find R. Prechter how is calling for a terrific decline in the next few weeks, as a proposed wave 3 down gets under way. You may find Larry Katz forecast that calls for a bottom of the bear market in March 2009, and thus a bull market to last for years to come. There is also Jeff Greenblatt who is talking about the completion of a 4th wave on the impulse down which begun in Oct 2007, and thus a potential for a new low, but not nearly as bearish as Prechter. With so much divergence, it is easy to become skeptical about the Elliott wave theory.

Today, I can say that the Elliott wave saved me from a big loss in the 2007-2009 decline, because I have not owned a stock or mutual fund since 2000. However, I DO maintain a love-hate relationship with the theory. I have learned to maintain my distance and only make trading decisions when when there is little or no ambiguity, and believe me, there is often a lot of ambiguity. It is only after a complete pattern that we can make a good forecasts, and even then, most elliotticians are way too exuberant and grandiose. So I have learned its limitations. From a traders perspective, here are some basic rules:

Elliott theory is based on mass psychology, so it makes sense to keep the forecast for highly traded instruments, most specially indices.
Gaps are problematic because they can be misleading as to how high or low a stock may have reached after hours. This is why I like the e-mini in daily charts, as it has no gaps to speak of.
You are not always going to get a good, reliable forecast, so only trade the reversal, once a pattern has been completed.
You always need to go the origin of a stock or index, but beware of interpretations from logarithmic transformations, they then to be inaccurate.
Beware of Elliott wave forecasting programs, particularly when you apply them to stocks, particularly low liquidity stocks. I have tried softwares that claim to produce reliable counts, but I invariably find myself in disagreement with the results. Understanding the Elliott rules and at least the 7 basic patterns is essential.

As a trader, I DO like to trade the Elliott wave reversals, but I am prepared to exit my trades not based on interpretation but on money management rules. Perhaps I might enter a small options position that I am prepared to lose entirely, or perhaps I might enter a bigger one, with a contingency stop order, but I never debate whether I shuold be right or wrong while my position is in place, there is always time to reevaluate my count and where I could have gone wrong.

Back in the 90’s, when we did not have such powerful internet services as today, I used to download historical data from Yahoo finance into my software (ProTA from Beesoft) and do my analysis. I used the approach described by Robert C. Beckman in his book “Elliott wave Explained”. It worked like a charm, while most stocks, specially technology stocks were in an impulse series. With the years, I have found that price charts can be trending up (or down), without necessarily being impulsive, and this is where Beckman’s method falls apart. Recently I have learned to adapt Beckman’s method to the interpretation of non-impulsive, trending patterns, and have found that once can easily interpret most patterns with this simple method, leaving the rare structures to the purists. However, I DO keep Gleen Neely’s book “Mastering the Elliott wave” handy because that book as a compilation of most possible patterns. However, it is critical for me as a trader to keep it simple and practical.

The Elliott wave is powerful, sometimes, and could save you a lot of grief, if you wait for the right time and signals to make a commitment to a trade. However, money management rules should still apply in order to avoid the arrogance of believing that you must be always right because of your wave interpretation.