By Jeffrey Kennedy
When I began my career as an analyst, I was lucky enough to have some time with a few old pros.
One in particular that I will always remember told me that a kid with a ruler could make a million dollars in the markets. He was talking about trendlines. I was sold.
I spent nearly three years drawing trendlines and all sorts of geometric shapes on price charts. And you know, that grizzled old trader was only half right.
Trendlines are one the most simple and dynamic tools an analyst can employ… but I have yet to make my million dollars, so he was wrong — or at least early — on that point.
Despite being extremely useful, trendlines are often overlooked. I guess it’s just human nature to discard the simple in favor of the complicated.
(Heaven knows, if they don’t understand it, it must work, right?)
In the chart above, I have drawn a trendline using two lows that occurred in early August and September of 2003.
As you can see, each time prices approached this line, they reversed course and advanced.
Sometimes, soybeans only fell to near this line before turning up.
Other times, prices broke through momentarily before resuming the larger uptrend.
What still amazes me is that two seemingly insignificant lows in 2002 pointed the direction of soybeans — and identified several potential buying opportunities — for the next six months!
Get more lessons like the one above in the free 50-page Ultimate Technical Analysis Handbook. Learn more and download your free copy here.
By Robert Prechter
Take it from the person who won the United States Trading Championship with profits of more than 440% in 1984 – there are five things that every successful trader needs to know how to do:
1. Have a method to trade.
2. Have the discipline to follow your method.
3. Get real trading experience, instead of only trading on paper.
4. Have the mental fortitude to accept the fact that losses are part of the game.
5. Have the mental fortitude to accept huge gains.
Bonus tip: Find a mentor.
That trader who won the championship in a record-breaking fashion is Robert Prechter, the founder and president of Elliott Wave International. Once you think you’ve mastered his 5 tips for how to trade successfully, then the best thing to do is to find a mentor. In this excerpt from the book, Prechter’s Perspective, Bob Prechter discusses how sitting at the elbow of a professional trader can make all the difference in learning the trade of trading.
(The following Q&A is excerpted from Prechter’s Perspective, revised 2004.)
Question: Has any specific trading experience decreased your trading success?
Bob Prechter: Yes. My first trade in 1973 was wildly successful, and I was hardly wrong in my first six years at it. Then I had a big trading loss in 1979, and that taught me more than the wins. The best way to develop an optimal state of mind for trading is to fail a few times first and understand why it happened. When you start, you’re better off speculating with small amounts of real money. Using larger amounts of money will bankrupt you early, which, while an excellent lesson, is rather painful. If you want to be a trader, it is good to start young. Then when you lose your first two bundles, you can gain some wisdom and rebound.
Q.: It sounds painful. Is there any way at least to reduce the hard knocks?
Bob Prechter: There is one shortcut to obtaining experience, and that is to find a mentor.
Q.: Did you have a mentor?
Bob Prechter: In 1979, I sat with a professional trader for about a year. The most important thing he taught me was to keep trades small relative to your capital. It reduces the emotional factor.
Q.: How would one select a mentor?
Bob Prechter: The best way to select one is to find a person who is doing exactly what you would like to do for a living, then get to know him well enough to ask if he will tutor you or at least let you watch while he works. Locate someone who has proved himself over the years to be a successful trader or investor, and go visit him. Listen to him. Sit down with him, if possible, for six months. Watch what he does. More important, watch what he doesn’t do. Finding a guy who knows what he is doing is the best lesson you could ever have. You will undoubtedly find that he is very friendly as well, since his runaway ego of yesteryear, which undoubtedly got him involved in the markets in the first place, has long since been humbled, matured by the experience of trading. He will usually welcome the opportunity to tell you what he knows.
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By Nico Isaac
In recent months, Elliott Wave International President Bob Prechter has become something of a household name. In the final two days of August 2009 alone, Bob was mentioned by several news outlets from MarketWatch to the New York Times. The claim to his “fame” –
EWI was one of the only technical analysis firms to anticipate a sharp rally in U.S. stocks as they circled the drain of a 12-year low this spring, a feat made ever more exceptional considering the widespread image of Bob as being the ultimate “Big, Bad Bear.”
The lesson? Believe in the facts, not in the “widespread image.”
Bob Prechter has always said that successful forecasting should look to the current wave count (and various other technical measures) for direction. He has never permanently tied himself to the mast of definition — i.e. “bull” or “bear.”
For this reason, EWI’s team of analysts have been able to stay one step ahead of the biggest turning points in the Dow Jones Industrial Average, from the very start of the index’s historic 2007 reversal.
To wit: This two-year chart of the Dow incorporates several calls from our past publications as they coincided with the market’s most memorable peaks and troughs:
The chart above presents the abstract details of our past analysis. Here is the expanded version of those insights as they appeared in real-time:
July 17, 2007 TheElliott Wave Theorist:
“Aggressive speculators should return to a fully leveraged short position now. We may be early by a couple of weeks, but the market has traced out the minimum expected rise, and that’s enough to act on.”
Soon after, as the DJIA neared its own historic Oct. 11, 2007 apex, the Oct. 9 and 10 Short Term Update amped up the urgency of its analysis and wrote:
“Odds have increased that a market high is in place. The structure, coupled with turns in the other markets, suggests a top is in place. The potential, at the least, is four a large selloff… Watch Out! The market faces a stout correction.”
Before landing at its March 10, 2008 bottom, the March 5 Short Term Update afforded respect to a bullish alternate count and wrote: “Prices should carry above the wave a high (13165) before it ends.”
At its four-month high, the March 16 2008 Elliott Wave Theorist went on high, bearish alert and wrote: The DJIA is entering “Free Fall territory.”
One week before the U.S. stock market landed at its 12-year low of March 9, our Feb. 27, 2009 Short Term Update utilized a traditional turning pattern to outline a specific time window for the onset of a major upside reversal. In STU’s own words:
“By all indication, this pattern is back on track… the turn will come on or near March 10, 2009. Anywhere in this time period may mark a turn, which will obviously be a market low.”
Once the bullish winds of change had turned, the March 16 Short Term Update wrote:
“When the market speaks, it behooves us to listen. The implications of this are that the… major stock indexes are in the initial stages of a multi-month advance.”
Finally, the April 2009 Elliott Wave Financial Forecast calculated a specific target range for the Dow’s rally: the 9,000-10,000 level.
So, now that the upside objective is met, where are prices set to go next? For more analysis from Robert Prechter, download a free 10-page July issue of Prechter’s Elliott Wave Theorist.
By Susan C. Walker
It’s a blessing and a curse. IRAs, 401(k)s, thrift plans — some of the best ways to save money for retirement (the blessing) can tie your hands when you invest that money (the curse). Most savers didn’t recognize the cursed side as the markets generally trended up over the years, increasing their nest eggs’ earnings. But after a year like 2008, savers everywhere absorbed the shock that they couldn’t protect their retirement savings from a bear market. Now, the real moment of truth arrives: EWI forecasts that the market will again turn bearish. How can you protect what you’ve got when your plan doesn’t have any options for short-side investing? Bob Prechter addresses that question in his most recent Theorist.
* * * * *
Excerpted from The Elliott Wave Theorist, by Robert Prechter, published August 5, 2009
Investment Vehicles and Government-Regulated Plans
We receive many emails from subscribers asking specific questions about investing [such as,] “Is it O.K. to invest in such-and-such short fund if that is my only short-side option?” Again, given the market-tracking mechanics of such funds, the only answer we can give in good conscience is “no.” … But every question prompts others. Why is this our friend’s “only option”? The funds mentioned are the only ones in which a “long” is really a short, so we would guess that our friend has some sort of government-regulated retirement plan that allows only “long-side” purchases.
Others with retirement plans similarly complain that their plans do not include the option of owning Treasury-only paper and ask if such-and-such other money fund is safe enough to buy. In our view, most money funds assuredly do not offer the level of safety that we advocate. Moreover, such plans are often administered by brokers, and brokers will be in chaos during wave 3 down.
These questions reveal just some of the problems an investor encounters when playing the government’s games. Conquer the Crash (see Ch. 23) recommended taking every opportunity to cash out of IRAs, Keoughs, company-provided plans, etc., all of which are government regulated, thereby freeing up your money so that you would have full say over its use.
By signing up for one of the government’s “deals,” a potential short seller now has no good choices and is therefore effectively barred from selling short. A prudent investor who wants to own the safest debt may likewise be barred from buying T-bills if he participates in a government-regulated, company retirement plan. Should he buy the only money fund available and cross his fingers? Government rules often force people into bad decisions. In this case, the “good deal” the government engineered for your retirement is a trap that prohibits you—at the most important time in modern history—from buying the safest debt instruments and from making money in a bear market….
Irony attends both financial markets and government plans. Put them together—as we have witnessed throughout the financial crisis so far—and you get Kafka.
Editor’s Note: The article discusses Robert Prechter’s view of investment vehicles and government-regulated plans. For more analysis from Robert Prechter, download a free 10-page July issue of Prechter’s Elliott Wave Theorist.
Efficient Market Hypothesis: True “Villain” of the Financial Crisis?
By Robert Folsom
When a maverick idea becomes vindicated, there’s a good story to tell. It usually involves a person (or small group of people) who courageously challenge the orthodoxy of the day — and, over time, the unorthodox yet better idea prevails.
A “good story” of this sort has surfaced during the current financial crisis. A chapter of the story appeared in a recent New York Times article, “Poking Holes in a Theory on Markets.” The theory in question is the efficient market hypothesis (EMH), which the article suggested is so hazardous that it “is more or less responsible for the financial crisis.” This quote tells you most of what you need to know:
“In the last decade, the efficient market hypothesis, which had been near dogma since the early 1970s, has taken some serious body blows. First came the rise of the behavioral economists, like Richard H. Thaler at the University of Chicago and Robert J. Shiller at Yale, who convincingly showed that mass psychology, herd behavior and the like can have an enormous effect on stock prices — meaning that perhaps the market isn’t quite so efficient after all. Then came a bit more tangible proof: the dot-com bubble, quickly followed by the housing bubble. Quod erat demonstrandum.”
In case your Latin is rusty, Quod erat demonstrandum means “which was to be demonstrated.” Its abbreviation (QED) appears at the conclusion of a mathematical proof. In this case, the massive financial bubbles of recent years are the proof that refutes the efficient market hypothesis, which argues that markets move in a “random walk” and are not patterned.
Similar articles in the financial press have reported the demise of the EMH. Just this week an Economist magazine blog included this bold declaration:
“No one has yet produced a version of the EMH which can be tested and fits the evidence. Thus, the EMH must logically be discarded, as a valid hypothesis must be testable.”
QED, indeed — I agreed years ago that the random walk was implausible. But I didn’t come to this view because of behavioral economists, although their work over the past decade has certainly been valuable. Instead, I was persuaded by the work of someone who first challenged the financial orthodoxy more than three decades ago, specifically April 1977. As a young technical analyst at Merrill Lynch in New York, his research circulated among several of Merrill’s clients. His name for these studies was the Elliott Wave Theorist: the April ’77 study was a detailed analysis of the 1975-76 stock market, which offered this comment on the random walk model:
“If market moves are arbitrary (as the random walk proponents suggest), then internal components would rarely ‘make sense’ mathematically, and then only by statistically insignificant fluke occurrences. However, there seems to be enough evidence that mass psychology, as recorded in the Dow Jones Industrials, form patterns that are uncannily interrelated….At least this much can be fairly reliably stated as a result of this work: This idea that the market is a ‘random walk’ is probably false.”
Robert Prechter left Merrill soon after; he has published the Elliott Wave Theorist in every month since. Every issue has, in one way or another, “convincingly showed that mass psychology, herd behavior and the like can have an enormous effect on stock prices.”
So while there may be a good story to tell about behavioral economists, I trust you see why I believe there is a vastly better one to tell.
The “enormous effect” of “mass psychology” and “herd behavior” is exactly what explains the financial downturn that began in late 2007. Prechter’s Elliott Wave Theorist anticipated the crisis and warned subscribers beforehand. Likewise, he alerted them to the bear market rally that began last March.
Editor’s Note: The following article discusses Robert Prechter’s view of the Efficient Market Hypothesis. For more information, download this free 10-page issue of Prechter’s Elliott Wave Theorist.
By Bob Prechter
The following is an excerpt from Robert Prechter’s Elliott Wave Theorist.
On February 23, EWT called for the S&P to bottom in the 600s and then begin a sharp rally, the biggest since the 2007 high. The S&P bottomed at 667 on March 6. Then the stock market and commodities went almost straight up for three months as the dollar fell.
On March 18, Treasury bonds had their biggest up day ever, thanks to the Fed’s initiating its T-bond buying program. The next day, EWT reiterated our bearish stance on Treasury bonds. T-bond futures declined relentlessly from the previous day’s high at 130-15 to a low of 111-21 on June 11.
That’s when there were indications of impending trend changes. The June 11 issue called for interim tops in stocks, metals and oil and a temporary bottom in the dollar. The Dow topped that day and fell nearly 800 points; silver reversed and fell from $16 to $12.45; gold slid about $90; and oil, which had just doubled, reversed and fell from $73.38 to $58.32. The dollar simultaneously rallied and traced out a triangle for wave 4. Bonds bounced as well. As far as I can tell, our scenarios at all degrees are all on track.
Corrective patterns can be complex, so we should hesitate to be too specific about the shape this bear market rally will take. But from lows on July 8 (intraday) and 10 (close), the stock market may have begun the second phase of advance that will fulfill our ideal scenario for a three-wave (up-down-up) rally. In concert with rising stocks, bonds have started another declining wave, and the dollar appears to have turned down in wave 5 (see chart in the June issue), heading toward its final low. Although commodities should bounce, their wave patterns suggest that many key commodities will fail to make new highs this year in this second and final phase of partial recovery in the overall financial markets.
Meanwhile, our forecast for a change in people’s attitudes to a less pessimistic outlook is proceeding apace. Here are some of the reports evidencing this change:
More than 90 percent of economists predict the recession will end this year. [The] vast majority pick 3rd quarter as the time. (AP, 5/27)
Manufacturing and housing reports this week may offer signs that the recession-stricken U.S. economy is within months of hitting bottom, economists said. (USA, 6/15)
Fewer people say they’ve prospered over the past year than in decades, a USA TODAY/Gallup Poll finds. Over the past two months, however, expectations for the future have brightened significantly amid rising optimism about a stock market rebound and economic turnaround. “I think the administration is going in the right direction,” says… Now 36% of those surveyed in the Gallup-Healthways well-being poll say the economy is getting better. That’s not exactly head-over-heels exuberance, but it is double the number who felt that way at the beginning of the year and a notable spike in the nation’s frame of mind. Thirty-three percent say they’re satisfied with the way things are going in the United States; in January, just 13% did. (USA, 6/23/09)
If only to confirm the socionomic causality at work, an economist quoted in the article above muses, “The one anomaly in the puzzle is that people shouldn’t be feeling better because the jobs market is so terrible and unemployment is likely to keep rising.” Of course it would be an anomaly, and people should not feel better, if mood were exogenously caused. But it is endogenously regulated, and it precedes social actions, which produce events such as job creation and elimination. That people feel better is evident in our rising sociometer, the stock market. If the rally continues, economists will soon agree that the Fed’s “quantitative easing” and Congress’ massive spending are “working.” Those predicting more inflation and hyperinflation will have the last seeming confirmation of their opinions. Then, a few months from now, some economists will probably express similar puzzlement when the stock market starts plummeting again despite the fact that the economy has improved.
But all of these considerations are temporary. Conditions are relative, and behind the scenes, the depression has been, and still is, grinding away.
For more information, download the FREE 10-page issue of Bob Prechter’s recent Elliott Wave Theorist. It challenges current recovery hype with hard facts, independent analysis, and insightful charts. You’ll find out why the worst is NOT over and what you can do to safeguard your financial future.