First, let me say that I used the Elliott wave in my life outside of trading to make financial decisions that saved me a fortune when all around were losing their savings. This is because I recognized the pattern that was developing in the stock market between 2000 and 2007 early, and avoided any large investments in real estate, or bonds or stocks, and focus instead on locking in high, long-term interest rates in CD’s between the period of 2004-2008. In addition I tapped into Options to create a strategy which would take advantage of sudden movements in the stock market, whether up or down. So, I DO believe that the Elliott wave is a great theory, but with big limitations most people don’t recognize because they do not stay long enough to find them and understand them.
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Over the last 2 years, I have focused on Elliott counts in short-term charts on the e-mini S&P500 futures. This instrument has the unique feature to trade day and night, except weekends. This is important because any swing in the stock price is important to the final evaluation of an Elliott Pattern. There are no “gaps” in the e-mini chart, so one can easily count an Elliott patter without ambiguity in 15min, 1hr, daily, or weekly charts with great accuracy.
The chart above shows what I mean. With little ambiguity, a completed pattern can be identified and thus a reversal recognized. You can only construct a smooth chart if: a. There are no gaps in the charts, which would hide significant market action, which may be essential for Elliott counts. b. The instrument is high liquid so the chart reflect the true sentiment of the participants as orders are filled in a timely fashion.
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Stocks often have big gaps that obscure the true pattern under development, obstructing rational decision making. In the chart of QCOM above, the Elliottician is unable to discern the true pattern in the movement. Is QCOM at the end of an elongated flat? or in the middle of a wave 3? perhaps wave X of a double zigzag is about to form? These may be important observations that an options trader could use to make decisions such as buying a put or a calendar spread in this case.
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An hourly chart is not any more revealing, when including after hours data. Even though there is after hours trading in this stock, there are significant limitations to this trading and the charts are not a good reflection of the sentiment. The long, red candle right after the earnings release is not an accurate representation of the true market action. But even before that, the candles seems quite inaccurate, particularly in after market action. An elliottician cannot rely on this hourly charts to accurately count short-term charts, and thus extrapolate to daily charts. Still, in some cases, provided that the stock is liquid enough, the gaps are smoothed out when weekly, rather than daily charts are used. Provided that the stock is heavily traded (liquid), and a consistent counting technique is used, a reasonable count can be achieved.
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In this weekly chart of AAPL, gaps are eliminated from the count and a double zigzag is revealed without much ambiguity. The daily chart may be used to confirm some of the movement. If there are gaps, the count is unreliable and the weekly chart is the only way out of for the elliottician. Therefore, Elliott have counting is a good long-term approach to investing in the markets but it is inaccurate for most swing/day trading. This conclusion is supported by years of observation , which vindicates my own use of the Elliott wave during the 90’s when I followed careful counts of a set of about 30 separate stocks. Similarly, other observations have also help me understand how I was be very wrong about some specific cases in which I lost money.
There are heavily traded stocks that could have reliable daily chart counts, as demonstrated from this chart of GS.
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The limited number of gaps reveal a sequence of ups and downs without the typical extension rule that applies to impulse theories as described by Elliott (Neely’s Litmus test). Understanding this is paramount in trying to make sense of chart patterns. Simplifying the approach to counting is the basis of profiting from Elliott wave analysis.
My observation of the E-mini S&P500 futures in hourly charts has put my understanding of the Elliott wave theory in to a great new perspective, and has helped me formulate a variation of Ralph Nelson Elliott theory using his original channeling method. I have kept the largest set of Elliott patterns described by Gleen Neely under my arm for consultation, but I have relied on Rich Swanelle’s most common patterns right on my desktop as common pattern occur almost exclusively. I am formulating a new theory that classifies Elliott patterns as Trending and non-trending while preserving the original classification of impulsive and corrective patterns. I have learned to recognize also ambiguous vs. unambiguous situations that could and should be used to profit from the markets and even make long-term decisions in our financial lives. Understanding the short-comings of the Elliott wave theory is just as important as understanding its strengths.
I believe that R.N. Elliott was a pioneer, and there have been great contributors to the original theory such as Prechter and Frost, Neely and Swanelle, but the original theory stands as strong today as does the original principles of genetic described by Mendel, although there have been significant modifications to those principles by Morgan for his work with the fruit fly, and Watson and Creek for their proposal of the DNA molecule. Careful observation can lead into the verification of some basic principles but it can also reveal complexities not understood by the original proposed theory.
For me, the Elliott wave theory is only useful to the extend that we can use it for what it was intended: to profit in the markets, and that has been the focus of my work. To dismiss the Elliott wave theory as unworkable or unreliable has been my temptation many times. My love-hate relationship with the Elliott wave has lead me to a point where I can confidently say that I get it!
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