🔸7.2 Cycles
Last updated
Last updated
The “cycle” approach to the stock market has become quite fashionable in recent years as investors search for tools to help them deal with a volatile, net-sideways trend. This approach has a great deal of validity, and in the hands of an artful analyst can be an excellent approach to market analysis. However, in our opinion, while it can make money in the stock market as can many other technical tools, the “cycle” approach does not reflect the true essence of the law behind the progression of markets.
Unfortunately, just as the Elliott Wave Principle in conjunction with Dow Theory and one or two related methods spawned a large public following for the “all bull markets have three legs” thesis, cycle theories have recently spawned a rigid adherence to the “four-year cycle” idea by many analysts and investors. Some comments seem appropriate. First, the existence of any cycle does not mean that moves to new highs within the second half of the cycle are impossible. The measurement is always low to low, regardless of intervening market action. Second, while the four year cycle has been visible for the postwar period (about thirty years), evidence of its existence prior to that time is spotty and irregular, revealing a history that will allow for its contraction, expansion, shift or disappearance at any time.
For those who have found success using a cyclic approach, we feel that the Wave Principle can be a useful tool in predicting changes in the lengths of cycles, which seem to fade in and out of existence at times, usually with little or no warning. Note, for instance, that the four-year cycle has been quite visible in most of the current Supercycle’s subwaves II, III and IV but was muddled and distorted in wave I, the 1932-1937 bull market, and prior to that time. If we remember that the two shorter waves in a five-wave bull move tend to be quite similar, we can deduce that the current Cycle wave V should more closely resemble wave I (1932-37) than any other wave in this sequence, since wave III from 1942 to 1966 was the extended wave and will be dissimilar to the two other motive waves. The current wave V, then, should be a simpler structure with shorter cycle lengths and could provide for the sudden contraction of the popular four-year cycle to more like three and a half years. In other words, within waves, cycles may tend toward time constancy. When the next wave begins, however, the analyst should be on the alert for changes in periodicity. Since we believe that the debacle currently predicted for 1978 and 1979 by the cycle theorists on the basis of the four- and nine-year cycles will not occur, we would like to present the following quotation from “Elliott’s Wave Principle — A Reappraisal” by Charles J. Collins, published in 1954 by Bolton, Tremblay & Co.:
Elliott alone among the cycle theorists (despite the fact he died in 1947, while others lived) provided a basic background of cycle theory compatible with what actually happened in the postwar period (at least to date).
According to orthodox cycle approaches, the years 1951- 1953 were to produce somewhat of a holocaust in the securities and commodity markets, with depression centering in this period. That the pattern did not work out as anticipated is probably a good thing, as it is quite doubtful if the free world could have survived a decline which was scheduled to be almost as devastating as 1929-32.
In our opinion, the analyst could go on indefinitely in his attempt to verify fixed cycle periodicities, with negligible results. The Wave Principle reveals that the market reflects more the properties of a spiral than a circle, more the properties of nature than of a machine.
Figure 7-3
Figure 7-3 is a chart, courtesy of Edson Gould and Anametrics, Inc., of the “decennial pattern,” as averaged out over the past seven decades in the stock market. In other words, this chart is a reproduction of the DJIA action, since its inception, for the composite decade, years one through ten. The tendency toward similar market action in each year of the decade is well documented and is referred to as the “decennial pattern.” Our approach, however, gives this observation a new and startling meaning. Look for yourself: a perfect Elliott wave.
While most financial news writers explain market action by current events, there is seldom any worthwhile connection. Most days contain a plethora of both good and bad news, which is usually selectively scrutinized to come up with a plausible explanation for the movement of the market. In Nature’s Law, Elliott commented on the value of news as follows:
At best, the news is the tardy recognition of forces that have already been at work for some time and is startling only to those unaware of the trend. The futility of relying on anyone’s ability to interpret the value of any single news item in terms of the stock market has long been recognized by experienced and successful traders. No single news item or series of developments can be regarded as the underlying cause of any sustained trend. In fact, over a long period of time, the same events have had widely different effects because trend conditions were dissimilar. This statement can be verified by a casual study of the 45-year record of the Dow Jones Industrial Average.
During that period, kings have been assassinated, there have been wars, rumors of wars, booms, panics, bankruptcies, New Era, New Deal, “trust busting,” and all sorts of historic and emotional developments. Yet all bull markets acted in the same way, and likewise, all bear markets evinced similar characteristics that controlled and measured the response of the market to any type of news as well as the extent and proportions of the component segments of the trend as a whole. These characteristics can be appraised and used to forecast future actions of the market, regardless of the news.
There are times when something totally unexpected happens, such as earthquakes. Nevertheless, regardless of the degree of surprise, it seems safe to conclude that any such development is discounted very quickly and without reversing the indicated trend under way before the event. Those who regard news as the cause of market trends would probably have better luck gambling at race tracks than in relying on their ability to guess correctly the significance of outstanding news items. Therefore the only way to “see the forest clearly” is to take a position above the surrounding trees.
Elliott recognized that not news, but something else forms the patterns evident in the market. Generally speaking, the important analytical question is not the news per se, but the importance the market places or appears to place on the news. In periods of increasing optimism, the market’s apparent reaction to an item of news is often different from what it would have been if the market were in a downtrend. It is easy to label the progression of Elliott waves on a historical price chart, but it is impossible to pick out, say, the occurrences of war, the most dramatic of human activities, on the basis of recorded stock market action. The psychology of the market in relation to the news, then, is sometimes useful, especially when the market acts contrarily to what one would “normally” expect.
Our studies suggest not simply that news tends to lag the market but that it nevertheless follows exactly the same progression. During waves 1 and 2 of a bull market, the front page of the newspaper reports news that engenders fear and gloom. The fundamental situation generally seems its worst as wave 2 of the market’s new advance bottoms out. Favorable fundamentals return in wave 3 and peak temporarily in the early part of wave 4. They return partway through wave 5, and like the technical aspects of wave 5, are less impressive than those present during wave 3 (see “Wave Personality” in Chapter 3). At the market’s peak, the fundamental background remains rosy, or even improves, yet the market turns down despite it. Negative fundamentals then begin to wax again after the correction is well under way. The news, or “fundamentals,” then, are offset from the market temporally by a wave or two. This parallel progression of events is a sign of unity in human affairs and tends to confirm the Wave Principle as an integral part of the human experience.
Technicians argue, in an understandable attempt to account for the time lag, that the market “discounts the future,” i.e., actually guesses correctly in advance changes in the social condition. This theory is initially enticing because in preceding economic developments and even socio-political events, the market appears to sense changes before they occur. However, the idea that investors are clairvoyant is somewhat fanciful. It is almost certain that in fact people’s emotional states and trends, as reflected by market prices, cause them to behave in ways that ultimately affect economic statistics and politics, i.e., produce “news.” To sum up our view, then, the market, for forecasting purposes, is the news.
Random Walk theory has been developed by statisticians in the academic world. The theory holds that stock prices move randomly and not in accord with predictable patterns of behavior. On this basis, stock market analysis is pointless as nothing can be gained from studying trends, patterns, or the inherent strength or weakness of individual securities.
Amateurs, no matter how successful they are in other fields, usually find it difficult to understand the strange, “unreasonable,” sometimes drastic, seemingly random ways of the market. Academics are intelligent people, and to explain their own inability to predict market behavior, some of them simply assert that prediction is impossible. Many facts contradict this conclusion, and not all of them are at the abstract level. For instance, the mere existence of very successful professional traders who make hundreds, or even thousands, of trading decisions a year flatly disproves the Random Walk idea, as does the existence of portfolio managers and analysts who manage to pilot brilliant careers over a professional lifetime. Statistically speaking, these performances prove that the forces animating the market’s progression are not random or due solely to chance. The market has a nature, and some people perceive enough about that nature to attain success. A very short-term trader who makes tens of decisions a week and makes money each week has accomplished something far less probable (in a random world) than tossing a coin fifty times in a row with the coin falling “heads” each time. David Bergamini, in Mathematics, stated,
Tossing a coin is an exercise in probability theory that everyone has tried. Calling either heads or tails is a fair bet because the chance of either result is one half. No one expects a coin to fall heads once in every two tosses, but in a large number of tosses, the results tend to even out. For a coin to fall heads fifty consecutive times would take a million men tossing coins ten times a minute for forty hours a week, and then it would only happen once every nine centuries.
An indication of how far the Random Walk theory is removed from reality is the chart of the first 89 days of trading on the New York Stock Exchange after the 740 low on March 1, 1978, as shown in Figure 2-16 and discussed therewith. As demonstrated there and in the chart of the Supercycle in Figure 5-5, action on the NYSE does not create a formless jumble wandering without rhyme or reason. Hour after hour, day after day and year after year, the DJIA’s price changes create a succession of waves dividing and subdividing into patterns that perfectly fit Elliott’s basic tenets as he laid them out forty years ago. Thus, as the reader of this book may witness, the Elliott Wave Principle challenges the Random Walk theory at every turn.
