The Elliott Wave Principle

Key To Stock Market Profits
by Frost & Prechter, (Expanded Edition1990)

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By Elliott Wave International
Ralph Nelson Elliott discovered the Wave Principle in the 1930s. Over the decades, his discovery was kept alive by a handful of individuals. A few of those, such as Bolton, Prechter and Frost, educated investors on how to use pattern analysis in financial markets. To help out Elliott Wave International's readers in learning the basics of the method, we put together a free 10-lesson online tutorial. Here's an excerpt. Read more.

 

 

 

 

The Elliott Wave Principle

Key To Stock Market Profits
by Frost & Prechter 
(Expanded Edition1990)

 

 

 

 

Ralph Nelson Elliott

Ralph Nelson Elliott is the father of the Wave Theory, which is commonly called and more accurately described as the Elliott Wave Principle. Born on July 28, 1871 in Marysville, Kansas, Elliott reached his ultimate achievement late in life by a circuitous route.

After a long career in various accounting and business practices, R.N. Elliott was forced into an unwanted retirement at the age of 58 due to an illness contracted while living in Central America. Needing something to occupy his mind while recuperating, he turned his full attention to studying the behavior of the stock market.

Elliott examined yearly, monthly, weekly, daily, hourly and half-hourly charts of the various indexes covering 75 years of stock market behavior. By November 1934, R.N. Elliott's confidence in his ideas of what is sometimes called the Wave Theory had developed to the point that he presented them to Charles J. Collins of Investment Counsel, Inc. in Detroit.

Collins had traditionally put off the numerous correspondents who offered him systems 
for beating the market. Not surprisingly, the vast majority of these systems proved to 
be dismal failures. Elliott's Wave Theory, however, was another story.

The Dow Jones averages had declined throughout early 1935, and advisors were turning negative with the memories of the 1929–32 crash fresh in their minds. On Wednesday, March 13, 1935, just after the close of trading — with the Dow Jones averages finishing near the lows for the day — Elliott, citing his Wave Theory analysis, sent a telegram to Collins and flatly stated:

“NOTWITHSTANDING BEARISH (DOW) IMPLICATIONS ALL AVERAGES ARE MAKING FINAL BOTTOM.”

The next day, Thursday, March 14, 1935, was the day of the closing low for the Dow Industrials that year. The 13-month “correction” was over, and the market immediately turned to the upside. Two months later, as the market continued its upward climb, Collins agreed to collaborate on a book on the Wave Theory. The Wave Principle was published on August 31, 1938.

During the early 1940s, the Wave Theory continued to develop. Elliott tied the patterns of collective human behavior to the Fibonacci, or “golden” ratio, a mathematical phenomenon known for millennia as one of nature's ubiquitous laws of form and progress.

Elliott then put together what he considered his definitive work, Nature's Law — The Secret of the Universe. This volume includes almost every thought he had concerning his Wave Theory.

 

 

 

Basic Tenets of the Wave Principle  

This chapter provides a succinct overview of the Wave Principle so that those new to the concept can get the idea as quickly as possible. That way, we can move on to address the validity of the concept of the Wave Principle and then discuss its implications and application. Full details are available in Elliott Wave Principle (1978/1998). This chapter is necessarily dry as a bone, but I promise that the steam will rise as we move along.  

 

R.N.Elliott’s Discovery  

In the 1930s, Ralph Nelson Elliott discovered that aggregate stock market prices trend and reverse in recognizable patterns. The patterns he discerned are repetitive in form, but not necessarily in time or amplitude. Elliott isolated and defined thirteen patterns, or “waves”, that recur in market price data. He named and illustrated the patterns. He then described how they link together to form larger versions of themselves, how they in turn link to form the same patterns at the next larger size, and so on, producing a structured progression. 
He called this phenomenon  The Wave Principle.

Many areas of mass human activity display the Wave Principle, but it is most popularly applied to stock market averages. There is voluminous, meticulously tabulated data on fincancial markets because people deem them important. Actually, the stock market is far more significant to the human condition than it appears to casual observers and even to those  who make their living by it. The level of aggregate stock prices is a direct and immediate measure of the popular valuation of man’s total productive capability. That this valuation has a form is a fact of profound implications that should ultimately revolutionize the social sciences.  

While Elliott progressed to the recognition of patterns and their linkage by a painstaking process of cataloging the minute details of price movement, we will forego such exercises and proceed directly to a description of the overall pattern.  

 

The Five-Wave Pattern  

In markets, progress ultimately takes the form of five waves of a specific structure. Waves (1), (3) and (5) actually effect the directional movement. Waves (2) and (4) are countertrend interruptions. The two interruptions are apparently a requisite for overall directional movement to occur. Elliott noted three consistent aspects of the five wave form. They are: Wave two never moves beyond the start of wave one, wave three is never the shortest wave, and wave four never enters the price territory of wave one. The stock market is always somewhere in the basic five-wave pattern at the largest degree of trend. Because the five-wave pattern is the overriding form of market progress, all other patterns are subsumed by it.  

 

Component Structures  

Figure 1 shows the first two waves in greater detail. Notice the difference in their subdivisions, which reflect the two modes of wave development: motive and corrective. The two modes are fundamentally different in both their roles and construction.

A motive wave (also called a “five”) has a five-wave structure. Its subwaves are denoted by numbers (in this case 1,2,3,4,5). Both the five-wave pattern and its same-directional components, i.e., waves (1),(3) and (5), employ motive mode. Their structures are called “motive” because they powerfully impel the market. A corrective wave (also called a “three”) has a three-wave structure or a variation thereof. Its subwaves are denoted by letters (in this case, A, B, C). All countertrend interruptions, which include waves (2) and (4) employ corrective mode. Their structures are called “corrective” because each one appears as a response to the preceding motive wave yet accomplishes only a partial retracement of the progress it had achieved, “correcting” its extremity.

 

Self-Similarity and Degree  

When the motive wave ends, a corrective wave of corresponding size follows, so that overall, the result looks like Figure 1. Observe that the overall form is the same as that of its own subwaves (1) and (2), depicted in Figure 1. The word “degree” has a specific meaning and does not mean “scale”. Component waves vary in size, but it always takes a certain number of them to create a wave of the next higher degree. Thus, each degree is identifiable in terms its relationship to higher and lower degrees. This is unlike the unfinite scaling relating to say, seacosts. Each same direction component of a motive wave (i.e., wave one, three or five) and each full-cycle component (i.e. waves one + two, or waves three + four) of a complete cycle is a smaller version of itself.

In Fig. 1, each subwave 1, 3,and 5 is a motive wave that must subdivide into a “five”, and each subwave 2 and 4 is a corrective wave that must subdivide into a “three”. Waves 1 and 2, if examined under a “microscope” , would take the same form as waves (1) and (2), and in further detail, waves [1] and [2], Regardless of degree, the form is constant.  We can use Fig.1 to illustrate two waves, eight waves or thirty-four waves, depending upon the degree to which we 
are refering.

 

The Essential Design  

 

  Figure 1 

 

The Essential Design  

Now observe that within the corrective pattern illustrated as wave (2), waves A and C, which point downward, are each composed of five waves: 1,2,3,4,and 5. Similarly, wave B, which points upward , is composed of three waves:A,B and C. This construction discloses a crucial point: Motive waves do not always point upwards, and corrective waves do not always point downward. The mode of a wave is determined not by its absolute direction but primarly by its relative direction. Aside from four specific exceptions, which are discussed in the literature, a wave divides in motive mode (five waves) when trending in the same direction as the wave of one larger degree of which it is a part, and in corrective mode (three waves  or a variation) when trending in the opposite direction. Waves A and C  [ (A) and (C) ]  are motive, trending in the same direction as wave [2]. Wave (B) is corrective because it corrects wave (A) and is countertrend to wave [2]. In summary, the essential underlying tendency of the Wave Principle is that action in the same direction as the one larger trend develops in five waves, while reaction against the one larger trend develops in three waves at all degree of trend.  

The phenomena of form, degree and relative direction are carried one step further in figure 1. This illustration reflects the general principle that in a market cycle , waves will subdivide a shown in the table below.  

 

  Number of Waves at Each Degree

 

 

                                  Impulse        +       Corrective         =   Cycle    

 

Largest waves                1                             1                         2

Largest subdivisions         5                             3                         8

Next subdivisions           21                            13                        34

Next subdivisions           89                            55                       144 etc.

 

 

Following the form, this larger cycle automatically becomes two subivisions of the wave of next higher degree. As long as progress continues, the process of building to greater degrees continues. The reverse process of subdividing into lesser degrees apparently continues indefinitely as well. As far as we can determine, then, all waves both have and are (or at the largest degree, will be) component waves.

 

Why 5-3 ?  

Elliott himself never speculated on why the market’s essential form was five waves to progress and three waves to regress. He simply noted that it was happening. Does the essential form have to be five waves and three waves? I think so.  

First, were there no fluctuation, there would be no progress. A steadily increasing trend of 3% per year, for instance, would be stasis; nothing would ever change. Fluctuation in a net sideways trend, i.e., one with no net change, would also be stasis. Progress must include setbacks and net change over time. From the point of view of a participant, punctuated progress is the only kind of progress that is possible to perceive.  

Second, the 5-3 pattern is the minimum requirement for, and therefore the most efficient method of, achieving both fluctuation and progress in linear movement when the only constraint is that the lengths of odd-numbered waves of each degree be longer than those of the even-numbered ones. One wave does not allow fluctuation. The fewest subdivisions to create fluctuation is three waves. Three waves in both directions do not allow progress. To progress in one direction despite fluctuation, movements in the main trend must be at least five waves, simply to cover more ground than the three waves. While there could be more waves than that, the most efficient form of punctuated progress is 5-3 , and nature typically follows the most efficient path.  

Fibonacci >>>

 

Notation and Nomenclature 

Waves are categorized by degree. The degree of a wave is determined by its size and position relative to component, adjacent  and encompassing waves.

Elliott named nine degrees of waves, from the smallest discernible on an hourly graph of stock prices to the largest he could assume existed from the data then available. He chose the following terms for these degrees, from largest to smallest: Grand Supercycle, Supercycle, Cycle, Primary, Intermediate, Minor, Minute, Minuette, Subminuette. Cycle waves subdivide into Primary waves that subdivide into Intermediate waves that in turn subdivide into Minor waves, and so on. This specific terminology is not critical to the identification of degrees, although out of habit, longtime practitioners have become comfortable with Elliott’s nomenclature. 

It is important to understand that these names and labels refer to specifically identifiable degrees of waves. By using a nomenclature, an analyst can identify precisely the positon of a wave in the overall progression of the market , much as longitude and latitude are used to identify a geographical location. To say, “The Dow Jones Industrial Average is  in Minute wave (v) of Minor wave 1 of Intermediate wave (3) of Primary Wave 5 of Cycle wave I of Supercycle wave (V) of the current Grand Supercycle” is to identify a specific point along the progression of stock market history.

 

Variations on the Basic Theme     

The basic model is simple, but reality is a bit more complex, as there are specific variations on the underlying theme that Elliott catalogued in detail. He also noted the important fact  that each pattern has identifiable rigidities  as well tendencies. From these observations, he was able to formulate descriptions of typical wave behavior and therefore rules and guidelines for proper wave identifications. For example, in the five-wave pattern (termed an “impulse”) , the middle wave is usually the longest, and the two corrective waves usually alternate in form, the first “sharp” , the second “sideways”. A thorough understanding of such details is necessary to know what the market can do, and at least as important,what it does not do. However,as the purpose of this chapter is limited to introducing the general hypothesis,a discussion of such nuances is omitted.  

 

Modern Science Comments on the Wave Principle Hypothesis 

1996 was an important year for the Wave Principle. In that year, the Journal of Physics published  a scientific study entitled ”Stock Market Crashes, Precursors and Replicas” by Didier Sornette and Anders Johansen, then of the Laboratoire de Physique de la Matiere Condensee at the University of Nice, France, and collaborateur Jean-Philippe Bouchard. The authors make this statement:

It is intriguing that the log-periodic structures documented here bear some similarity with the “Elliott waves” of technical analysis (citation Elliott Wave Principle). Technical analysis in finance can be broadly defined as the study of financial markets, mainly using graphs of stock prices as a functions of time, in the goal of predicting future trends. A lot of effort has been developed in finance both by academic and trading institutions and more recently by physicists (using some of their statistical tools developed to deal with complex time series) to analyze past data to get information on the future. The “Elliott wave” technique is probably the most famous in the field. We speculate that the “Elliott waves” … could be a  signature of an underlying critical structure of the stock market. ²  

¹ Elliott, R.N. (1938). The wave principle.

² Sornette,D., Johansen A., and Bouchard, J.P. (1996). “Stock market crashes, precursors and replicas.” Journal de Physique I France 6, No.1,pp.167-175. 

The Wave Principle of Human Social Behavior and The New Science of Socionomics,©1999 by Robert R. Prechter Jr.

   

 

Terminology and Labeling

 

Wave Degree	5's With the Trend	3's Against the Trend
Grand Supercycle	[I] [II] [III] [IV] [V]	[A] [B] [B]
Supercycle	(I)  (II) (III) (IV) (V)	(A) (B) (C)
Cycle	I   II   III   IV   V	A    B   C
Primary	[1] [2] [3] [4] [5]	[a] [b] [c]
Intermediate	(1) (2) (3) (4) (5)	(a) (b) (c)
Minor	1   2   3   4   5	a  b  c
Minute	(i)  (ii)  (iii)  (iv)  (v)	(a) (b) (c)
Minuette	i   ii    iii    iv    v	a  b  c
Subminuette	.i  .ii  .iii  .iv  .v	.a  .b  .c

(Labeling adjusted, Elliott today)

Literatur : The Wave Principle of Human Social Behavior and the New Science of Socionomics, 1999, Robert Rougelot Prechter,Jr., New Classics Library, Gainesville, GA, USA Elliott Wave Principle, Expanded Edition, Frost & Prechter, 1990

 

 

DJIA September 1986 - August 1987

Late November 1986 right in time with the so called Boesky-affaire ["Wall Street" - Michael Douglas & Charly Sheen] the DJIA finished wave e of a triangle in Intermediate wave (4). At the high of July 1986 the DJIA already gained 1.618 times the length of wave (1) and at that time we expected wave (5) to unfold to new record highs to complete the primary degree five wave structure from the low of 577 points back in 1974.

Figure 2 shows the detail of 5 Minor waves to complete Intermediate wave (5). As you can see, not only does the wave subdivide i,ii,iii,iv and v [1,2,3,4,5], but it also travels within a parallel trend channel. Waves 2 and 4 sport alternation by taking different forms (zigzag and triangle), thus satisfying the most guideline of impulse wave formation.

Here is the point of discussion. The herding impulse, rather than the rational neocortex, drives the decisions of most financial market participants. Both the herding impulse and its attendant emotions are hard-wired nearly identically into people's unconscious minds. Whatever certain individuals may decide rationally, such decisions are diverse, and the herding impulseis ubiquitous. Thus, in the aggregate, individual rational decisions tend to cancel out, leaving herding impulses to determine the market's overall trend. EWT, March 2001 

 

 

Prechter's  Forecast For The Superbullmarket

13.September 1982 + 6.April 1983 

[The Wave Principle of Human Social Behavior and the New Science of Socionomics, 
Robert R.Prechter 1999]

This is a thrilling juncture for a wave analyst. For the first time since 1974, some incredible large wave patterns may have been completed, patterns that have important implications for the next five to eight years. The technical name for wave IV by this count is a “double-three”, with the second “three” an ascending triangle. This wave count argues that the Cycle wave IV correction from 1966 ended last month (August 1982). The lower boundary of the trend channel from 1942 was broken briefly at the termination of this pattern. A brief break of the long term trendline, I should note, was recognized as anoccasional trait of fourth waves, as shown in R.N.Elliott’s Masterworks. 

The task of wave analysis often requires stepping back and taking a look at the big picture and using the evidence of the historical patterns to judge the onset of a major change in trend. Cycle and Supercycle waves move in wide price bands and truly are the most important structures to take into account. They indicate, a period of dramatically stability and soaring stock prices has just begun. One must conclude that a bull market beginning in August 1982 would ultimately carry out its full potential of five times its starting point, thus targetring 3885. 

[Note: In the midst of the most extreme stock market pessimism since 1942, Prechter identified the end of a 16-year-period of net loss for the Dow a month after its end at 777 and projected a climb to what was perceived as an absurd level of nearly 4000.] 

A normal fifth wave will carry , based on Elliott’s channeling methods, to the upper channel line, which in this case cuts through the price action in the 3500-4000 range in the latter half of the 1980’s. Elliott noted that when a fourth wave breaks the trend channel [as this one did in 1982], the fifth will often have a throw-over, or a brief penetration through the same trend channel on the other [i.e. top] side. 

What might we conclude about the psychological aspects of wave V? 

As the last hurrah, it should be  characterized , at its end, by an almost unbelievable institutional mania for stocks and a public mania for stock index futures, stock options, and options on futures. In my opinion, the long term sentiment gauges will give off major trend sell signals two or three years before the final top, and the market will just keep on going. In order for the Dow to reach the heights expected by the year 1987 or 1990, and in order to set up the U.S. stock market to the Wave Principle, is due to follow wave V, investor mass psychology should reach manic proportions, with elements of 1929, 1968 and 1973 all operating together , and, at the end, to an even greater extreme. 

 

 

 

 

 

"Motive waves do not always point upward, 
and corrective waves
do not always point downward." 

(The Wave Principle of Human Social Behavior 
and the New Science of Socionomics, Robert R.Prechter, 1999. p.26-27.)

 

Corrective Waves

The single most important rule that can be gleaned from a study of the various corrective patterns is that corrections can never be fives. Only impulse waves can be fives. In other words, an initial five-wave movement against the larger trend is never the end of a correction, only part of it. [Elliott Wave Principle, Frost & Prechter,1990, p.34]

"Motive waves do not always point upward, and corrective waves do not always point downward." (The Wave Principle of Human Social Behavior and the New Science of Socionomics, Robert R.Prechter, 1999. p.26-27.)

 

 

 

Describing in What Ways Waves Are Identical 
and in What Ways They Are Variable 

The concept of a robust fractal is difficult to depict visually because a single illustration cannot convey both those aspects of an Elliott wave that are invariant and those that are variable, i.e., what its manifestations have in common and what they need not. We can draw the essence of an Elliott wave but not state the precise path that any manifestation of it will actually take. Elliott waves in reality always conform to a few simple rules of patterning, but vary considerably within that format.

Elliott described five elementary patterns in the stock market, which he called impulse, diagonal triangle, zigzag, flat and triangle. The first two occur in motive mode (i.e. when prices are moving in the direction of the trend of one larger degree, effecting the larger wave’s progress), while the latter three occur in corrective mode (i.e. when prices are moving opposite the direction of the trend of one larger degree, punctuating its progress). In corrections, sometimes two of the patterns 
will occur side by side, interrupted by an intervening zigzag, as noted under the heading , “Double Three.”

Each of the five elementary patterns has its own description as well as a short catalog of variations that are similarly delineated by differences in form . For instance, sometimes both boundary lines of a triangle slope toward each other , and sometimes either the top or bottom line is horizontal. As another example, somtetimes wave B of a flat ends at the level of the start of wave A , and sometimes it ends beyond it. Elliott attached a name to each of these differences in form so that with his terms, we know immediately what form and variation we are talking about.

If Elliott was anything, he was menticulous. His description of waves, their position within larger waves, and their relative frequency of occurrence have stood the test of sixtiy years’ intensive application by some very dedicated practitioners, with only minor modifications. (The Wave Principle of Human Social Behavior and the New Science of Socionomics, Robert R.Prechter, 1999. S.57-60.)    

Now observe that within the corrective pattern illustrated as wave (2) , waves a and c, which point downward, are each composed of five waves: 1,2,3,4 and 5. Similarly, wave b , which points upward is composed of three waves: a,b and c. This construction discloses a crucial point:  

Motive waves do not always point upward, and corrective waves do not always point downward.

The mode of a wave is determined not by its absolute direction but primarily by its relative direction. Aside from four specific exceptions, which are disscussed in the literature, a wave divides in motive mode (five waves) when trending in the same direction as the waves of one larger degree of which it is a part, and in corrective mode (three waves or a variation) when trending in the opposite direction. Waves a and c are motive, trending in the same direction as wave (2). Wave b is corrective because it corrects wave a and  is countertrend to wave (2). In summary, the essential underlying tendency of the Wave Principle is that action in the same direction as the one larger trend develops in five waves, while reaction against the one larger trend develops in three waves, while reaction against the one larger trend develops in three waves, at all degree of trend. (The Wave Principle of Human Social Behavior and the New Science of Socionomics, Robert R.Prechter, 1999. S.26-27.)

 

The Alltime-high January 14,2000

DJIA 1998 - 2000

"Five Waves Up" 

 

Sign Of A Top

Die Abbildung zeigt den DJIA vom Oktober 1998 bis Januar 2000. 

5 Wellen vom Tief vom Oktober 1998 wurden am 14.Januar 2000 komplettiert. Die Struktur ist eine klassische Elliott Wave Impulswelle. Wenn 5 Wellen komplett sind braucht es kein Warum, Wenn und Aber - die folgende Sequenz ist eine Korrektur - eine a-b-c (Variationen) Struktur. Alle Begründungen, Meinungen, künstlich hergestellte kausale Zusammenhänge, haben keine Bedeutung. Der Markt hat immer Recht ! 

There is more information the market or the market structure has given to us. According to Elliott the supposed setback will carry the market back to the price zone of the previous fourth wave of one lesser degree. 

 

Wave Principle: The Preferred & the Alternate Counts
5/24/2007 3:21:25 PM

Those who are new to the Wave Principle sometimes wish that it would identify one wave count on a price chart as the one and only correct count. What they forget is that wave analysis is no magic bullet for seeing into the future, just as no other tool of technical or fundamental analysis is a magic bullet. Like most analytical tools, the Wave Principle involves probabilities. Price charts offer probable wave counts, and an investor must choose the one that seems to be most probable, the next most probable, and so on. The Wave Principle does offer an advantage, though: It provides rules and guidelines that help investors to determine which wave count is most likely and to know when a wave count no longer applies. In this excerpt from Bob Prechter and A.J. Frost's seminal book about R.N. Elliott's Wave Principle, the authors explain why the alternate count matters to anyone who trades.

* * * * *

Excerpted from Chapter 2 of Elliott Wave Principle: Key to Market Behavior by A. J. Frost and Robert R. Prechter

The Preferred Count – Limiting the Possibilities

Without Elliott wave analysis, there appear to be an infinite number of possibilities for market action. What the Wave Principle provides is a means of first limiting the possibilities and then ordering the relative probabilities of possible future market paths. Elliott's highly specific rules reduce the number of valid alternatives to a minimum. Among those, the best interpretation, sometimes called the 'preferred count,' is the one that satisfies the largest number of guidelines. Other interpretations are ordered accordingly. As a result, competent analysts applying the rules agree on both the list of possibilities and the order of probabilities for various possible outcomes at any particular time. That order can usually be stated with certainty.

Do not assume, however, that certainty about the order of probabilities is the same as certainty about one specific outcome. Under only the rarest of circumstances do you ever know exactly what the market is going to do. You must understand and accept that even an approach that can identify high odds for a fairly specific event must be wrong some of the time.

The Alternate Count – Putting Unexpected Market Action into Perspective

You can prepare yourself psychologically for such outcomes through the continual updating of the second best interpretation, sometimes called the "alternate count." Because applying the Wave Principle is an exercise in probability, the ongoing maintenance of alternative wave counts is an essential part of using it correctly. In the event that the market violates the expected scenario, the alternate count puts the unexpected market action into perspective and immediately becomes your new preferred count. If you're thrown by your horse, it's useful to land right atop another.

Always invest with the preferred wave count. Not infrequently, the two or even three best counts comfortably dictate the same investment stance. Sometimes being continuously sensitive to alternatives can allow you to make money even when your preferred count is in error. For instance, after a minor low that you erroneously consider to be of major importance, you may recognize at a higher level that the market is vulnerable again to new lows. This recognition occurs after a clear-cut three-wave rally follows the minor low rather than the necessary five, since a three-wave rally is the sign of an upward correction. Thus, what happens after the turning point often helps confirm or refute the assumed status of the low or high, well in advance of danger.

A Built-in, Objective Method for Placing a Stop

Even if the market allows no such graceful change of opinion, the Wave Principle still offers exceptional value. Most other approaches to market analysis, whether fundamental, technical or cyclical, have no good way of forcing a reversal of opinion or position if you are wrong. The Wave Principle, in contrast, provides a built-in objective method for placing a stop. Since wave analysis is based upon price patterns, a pattern identified as having been completed is either over or it isn't. If the market changes direction, the analyst has caught the turn. If the market moves beyond what the apparently completed pattern allows, the conclusion is wrong, and any funds at risk can be reclaimed immediately.

Of course, there are often times when, despite a rigorous analysis, there is no clearly preferred interpretation. At such times, you must wait until the count resolves itself. When after a while the apparent jumble gels into a clear picture, the probability that a turning point is at hand can suddenly and excitingly rise to nearly 100%. It is a thrilling experience to pinpoint a turn, and the Wave Principle is the only approach that can occasionally provide the opportunity to do so.


Those who are new to the Wave Principle sometimes wish that it would identify one wave count on a price chart as the one and only correct count. What they forget is that wave analysis is no magic bullet for seeing into the future, just as no other tool of technical or fundamental analysis is a magic bullet. Like most analytical tools, the Wave Principle involves probabilities. Price charts offer probable wave counts, and an investor must choose the one that seems to be most probable, the next most probable, and so on. The Wave Principle does offer an advantage, though: It provides rules and guidelines that help investors to determine which wave count is most likely and to know when a wave count no longer applies. In this excerpt from Bob Prechter and A.J. Frost's seminal book about R.N. Elliott's Wave Principle, the authors explain why the alternate count matters to anyone who trades.

 

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Social Visioning as an Aspect of Herding

Why does a vast plurality of observers find extremely high or low financial market valuations utterly justifiable during their occurrence yet so obviously crazy in retrospect? That the majority (of money, actually and therefore usually people) at the time of extreme valuation believes it to be sensible is true by definition , or the pricing would not exist. Years later, historians look back at the time and cluck about how absurd prices were. Yet "every age," said Charles Mackay in 1852, "has its peculiar folly; some scheme, project or fantasy into which it plunges, spurred on either by love of gain, the necessity of excitement, or the mere force of imitation." 

Mackay uses the word "fantasy," as have a number of psychologists since. While mood definitely precede that action, it is not necessary that fantasy images precede that action. Herding people feel a certain way and can express themselves impulsively to reflect those feelings. They need not share any specific fantasy or image, just a mood. Nevertheless, the idea does fit the Wave Principle, so it may be that shared fantasy images are an intermediate step between mood change and resulting action. 

Several social scientists have proposed models that involve people sharing a social vision that serves as a benchmark against which they judge the world. Unlike physical benchmarks, social visions change. Trends based upon subjective mental imagery undergo violent reversals when that imagery dissolves. The unconscious use of an inconstant benchmark explains why people may believe fully a dream of perpetual prosperity one decade and succumb fully to a despairing nightmare of imminent doom the next. Their minds adapt to the group's changes in attitude as if reality itself had changed (and as a result, it usually does).

In 1952, Wilfred R.Bion presented a paper to the International Journal of Psychoanalysis on small-group dynamics. He characterized them as based upon primitive, shared unconscious fantasies, images or myths that come about as a way of relieving the pressure of, and evading the effort of, maintaining a rational, problem-solving orientation. Psychologist Carl Jung, many of whose ideas are controversal for good reason, nevertheless addressed the idea of human herding in terms that are not imcompatible with this view. He proposed that all individuals inherit, both genetically and by cultural transmission, ideational forms, or "archetypes," that are "collective, universal and impersonal" and which together form a "collective unconscious" social mind that rules emotinally-based social behavior. Jung's "archetype" is essentially an unconsciously shared social dream, fantasy, image or myth.

Psychologist Lloyd deMause presents a case for a "psycholgenic theory of history," whereby adults in groups first generate shared fantasies based upon childhood experience, then project them as images, and then act them out. He cites as evidence the fact that social images in news photographs, cartoons, advertisements, political speeches, entertainment media and so on precede events that then appear to mimic those images. This theory is not incompatible with the Wave Principle. Socionomics is based upon the idea that social mood is responsible for the character of social action. Since mood is expressed immediately in countless ways other than buying or selling stocks, expressions of the prevailing mood probably do include public visual images. These images would reflect mood quite immediately, before the public could mobilize itself enough to act in the economic and political arenas. However, I expect that the hypothesized connection of these images to childhood experience is derived from Freudian ideas, making that aspect of the theory highly conjectural. In light of the information in Chapter 8, I suggest that such images wold necessarily coalesce around the concerns of the limbic system and therefore be evolutionarily primitive in their nature. The resulting images might appear to a psychologist as childlike, although children are not typically obsessed with wealth, death, survival or sex (which concerns shape many social images),and the limbic system is. 

Regardless of any asscoicated psychoanalytics, the essential idea of social visioning has had staying power, finding its way into such modern social words as "paradigm." Science historian Thomas Kuhn, for instance, defines this term as "the entire constellation of beliefs, values, techniques, and so on shared by the members of a given community."

Swiss economist Eugene Bohler brings us closer to the subject of finance when he says, "The modern economy is as much 
a dream factory as Hollywood." Terms such as "fantasy" and "social dream" might appear overdone to many readers. As a close observer of the public's view of the stock market for many years, I find these terms uterly compatible with reality. What words better describe the results of a poll in late 1997 showing that on average, U.S. mutual fund investors expect their funds to gain 34% per year for the next ten years? (From a poll conducted by Montgomery Asset Managment ,San Francisco, released October 1997)

If social visioning is an intermediate step between social mood and social action, the dynamics of its manifestation would have to follow the Wave Principle, which governs its cause. It may well do exactly that. In 1965, B.W. Tuckman presented research on the developmental sequence of the psychological dynamics of small groups. Expanding upon his observations in the 1980s, psychiatrist Philip Wells Shambaugh of the Harvard Medical School, an expert on small-group dynamics, observed a certain style of progress in the images that such groups share and made this report:

The development of small groups, in its simpliest form, proceeds in a series of five waves, alternatingly positive and negative. 
I began to wonder, why such an undulation occurs and hypothesized that each stage of group development is patterned by 
an underlying shared fantasy. The first is the primordial paradise fantasy, the second, a negative phase, includes a number of competing fantasies, all marked by anger and hatred, the third (is marked) by the image of a Morean utopia, the fourth, again negative, is not often described but probably involves the decay of the utopian image, and the fifth, positive is of a democratic group structure. If one accepts (Prechter's) thesis that the Elliott wave form is based on mass psychology, it makes sense...The homologizing between the fantasies of small groups and large groups (becomes) quite essential in this nexpected context.

If social visioning occurs, and it it follows the Wave Principle, then people must share images and their associated feelings 
all the time, just as the Wave Principle is operating all the time. There is no reason to believe that people share images only 
at extremes in valuation or emotion, which only reflect their intensity. People often do share visions of boundless abundance or certain destruction, but these are the poles in the scale. In between, there are various degrees of optimism or pessimism and of uncertainty about the future, whose associated images would be correspondingly moderate. Pricing extremes in the stock market would reflect the power of social visions, and trend durations their persistence.

(The Wave Principle of Human Social Behavior, p.168-170, Robert R.Prechter, 1999)

 

Ökonomen verbreiten Optimismus 
Spiegel online de., May 15,2009

US-Investor Soros ruft Ende der Krise aus FTD de, May 11,2009

 

Ökonomen sehen Ende des Abschwungs
Spiegel de., May 8,2009

 

 

Feedback as Characteristic of Financial Markets and Society

Like societies as a whole, financial markets are a quintessential example of systems whose results feed back into the system as new cause. As the most widely followed market index in the world, the Dow Jones Industrial Average not only reflects the pulse of investors, it affects the pulse of investors. Not only do investor's decision make the Dow move in a direction, but the direction of the Dow often causes investors to make those very decision. Every day, investors watch the same ticker tape, read the same newspapers, listen to the same financial television shows and watch the same market indices go up and down. The same information, opinions and emotional expressions are absorbed and reflected by millions of people involved in the market. It is almost as if the participants are in a town square, and an orator trying to whip up revolution is standing on a balcony, making the crowd's emotions wax and wane with each change in content, tone and volume. In the case of markets, however, the orator and crowd are mostly one and the same. Much of Wall Street's information, such as price level, direction, speed of price change and volume, is self-generated, and just like a mob, the financial community feeds off its own emotions. The reason is that every market decision is both produced by information and produces information. Each transaction, while at once an effect, becomes part of the market and, by communicating transactional data to investors, joins the chain of causes of others' behavior. This process produces a mass feedback loop, which is governed by man's unconscious social nature. Since he has such a nature, the process repeatedly generates the same forms. 

Stock averages even allow the crowd to monitor itself, like fashion-conscious people watching each other at a shopping mall. In their function as monitors, averages such as the Dow Jones Industrial Average must be maintained as a standard. Let us explore this idea as it relates to the integrity of the DJIA. There is an oft-cited and not unreasonable objection to using the Dow in analysis or forecasting, which is that its components are not constant. For instance, Dow Jones & Co. replaces stocks in its averages from time to time, and occasionally one of the stocks splits. Either event changes the relative weightings of the individual issues, in the average. Many people call such changes "distortions," implying that this stock average is a rubber yardstick.

A spokesman for Dow Jones & Co. who maintains the Dow averages, admittedly a partisan on this issue, says, "The components may change with the times, but what the Dow represents remains constant." The precision of the DJIA's long-term wave structures and price relationships over the years supports this view unequivocally. The constancy of the Dow is also revealed by its continually constructing long-term parallel trend channels according to Elliott's observation. For instance, even though Dow Jones & Co. substitued MMM for Anaconda in its premier average 1976, the 1977-1978 decline still took the Dow exactly to a 0.618 retracement of the 1974-1976 advance, reaching a target I published in advance, as detailed in Chapter 4 of Elliott Wave Principle. Despite several splits and substitutions, the Dow's rise from 1974 nevertheless topped in 1987 within 0.07% of a level that made the 1974-1987 advance in percentage terms precisely equal to that of 1932-1937, fulfilling a wave relationship that A.J.Frost called for nine years in advance in Elliott Wave Principle.

Because of all this experience, it is clear to me that investors have a complex emotional relationship with the Dow as such, as an entity in itself, much as fans remain loyal to a sports team despite the continual replacement of individual players. Professional investors' action reflects this loyalty when they adjust their portfolios after a change in Dow or (S&P) components. They make such adjustments either to mimic what Dow Jones & Co. did or under the assumption that other people will do so. Each of these reasons conforms to the herding impulse.

 

 

I'm Still Bullish on This Market: Portfolio Manager
Friday, 14 May 2010, CNBC News 

Stocks continued to pull back on Friday as worries about the European debt crisis overshadowed somewhat encouraging U.S. economic data. Andrew Kanaly, chairman of Kanaly Trust Company, and Art Nunes, portfolio manager at IMS Capital Management, discussed their market outlooks. 

“We’ve been in a cyclical bull market for 14 months and the primary trend remains higher,” Nunes told CNBC. 

“We find ourselves in the third correction in this bull market and, so far, the primary trend at the 200-day moving average is holding just fine.” 

Nunes said earnings and sales are recovering and expects them to accelerate higher.

 

Angst vor Inflation
Gold! Gold! Gold!
14.05.2010, 
Anleger hamstern Gold - vor den Bankschaltern bilden sich bereits lange Schlangen. Die Bemühungen der Europäischen Zentralbank, die Angst vor Inflation zu zertreuen, laufen ins Leere. 
sueddeutsche de., 15.Mai 2010

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