Elliott Backwash

Nobody likes to hear bad news or even a prediction of bad news, judging from subscriber responses to Monday's lead feature "Markets' Wave of Fear" by economist Patrick O'Leary. Like many economists, O'Leary regards the Elliott Wave as one of the most significant of the market-based "predictive systems" and was prompted to tell readers about a recent fearful prediction from Robert Prechter, the world's leading authority on Elliott Wave theory. Prechter has predicted the Dow Jones will shed more than three-quarters of its current value, and plunge a staggering 7000 points by March 2007.

The suggestion drew a strong response. Some subscribers wrote to Eureka Report as supporters of Prechter, but most responses were negative, suggesting such predictive systems are a distraction from the serious business of investing successfully.

The Elliott Wave school of forecasting was developed in the US by Ralph Nelson Elliot in the 1930s. It is essentially a form of investment analysis that describes the way in which the mood of the masses swings between pessimism and optimism. Based on what is known as the Fibonacci sequence, it claims that the market swings back and forth in a natural sequence that vary in intensity, similar to tidal patterns.

In theory, the Elliott Wave should assist investors in identifying and anticipating market movements, telling investors what to do next and '” more importantly '” what not to do next.

O’Leary’s article examined the Elliott Wave in the overall context of economic analysis. He suggested the Elliott Wave is as relevant or irrelevant as any predictive system, depending on whether you believe it. However, the Elliott Wave theory is significant because it has an exceptionally large band of followers. Lynley Coldstream, the director of Elliott Wave Australia, says there are at least 500 followers in the local market.

O'Leary also noted the results of Elliott Wave research are wide open to interpretation.

Prechter has supporters among traders, economists and investors of all kinds. His views have been published in The New York Times, The Economist, Forbes and Time magazine. As the president of Elliott Wave International, he is the figurehead for affiliate organisations that exist in all corners of the earth.

He has been widely credited with forecasting the long decline in US stockmarket values in the wake of the NASDAQ reversals of early 2000. He has also become known as one of the few who called the crash of 1987.

Unfortunately for Prechter and his disciples, he was clearly too optimistic in his assessment of US stock values in months following the crash of 1987. A Time magazine special report, published a week after the crash, quoted Prechter as saying: "The bull market remains intact."

Prechter was using the Elliott Wave to predict that the Dow would soar to 3600 by 1988. The Dow would eventually reach 3600 '” but not until 1993. The open nature of the Elliott Wave means its adherents have been able to explain these anomalies over the years.

An important part of Elliott Wave theory is the ability to identify trends within trends. The theory stipulates there is a direct relationship between short-term and longer term patterns. The difficulty in this lies in being able to pinpoint the markets current position in the cycle. A mistake here could send strategies, and portfolios, in the wrong direction.

Lynley Coldstream says she applies Elliott Wave principles on a case-by-case basis; she makes the point that she is not bound to blindly follow any of Prechter's forecasts.

Coldstream told Eureka Report: "I do think that some of Prechter’s predictions did damage the reputation of the theory. Some people simply read Prechter’s work without themselves looking into it further. Elliott Wave is more than just instructions; it is an analysis tool to be used and interpreted in various ways."

The differing views of the world’s most noted exponent of the Elliott Wave theory and its Australian spokesperson illustrates just how open to interpretation such predictive systems can be.

There are literally dozens of prediction systems available, of which Elliott Wave is simple the best-known. There are pure math systems like fractals that coexist alongside less conventional methods like tea leaf readings and astrology (don’t laugh). The Magi Astrology Society, for example, claims to have predicted Black Monday 1987 by way of heliocentric astrology. Click here for more details.