we merely step back and wait for the Elliott Wave pattern to produce a situation which can be defined with greater precision. I have always stressed the need for “masterly inactivity” on various occasions in the stock market. One need not seek a message with every single price movement every single day. Some price movements cannot be categorised until we move further on in the cycle. The most rewarding aspect of the Elliott Wave Principle is that when only one alternative is offered the probability for success is extraordinarily high as will be demonstrated as we proceed. The longer term investor need only deal with the longer term Wave developments whose terminal junctures are easily recognisable. There are two aspects of prime importance when embarking on a study of the Wave Principle. The first is mastery of the tenets which is not very difficult. The second is learning how to work with the Wave Principle, a subject badly neglected by practitioners. That particular subject is the primary function of this book.
At the 1972 Investors Bulletin Annual Seminar, James Dines said, “A genius by the name of R. N. Elliott developed something called the Elliott Wave Principle but it takes a genius to understand it.”
Bear with me. You are about to become a “genius”!
Figure 2. F.T. 30. JAN 1975-FEB 1976
Two: Reality in the Stock Market
“It is, of course, easy from any set of statistics to prove that it is or is not. The National Bureau of Economic Research under Wesley Mitchell and Arthur Burns refuse to have any truck with thoughts about periodicity or form. Perhaps they are right. Perhaps all changes in the economic scene are due to accidental impulses which when totalled up come to a net of plus or minus factors without rhyme or reason. On the other hand, nothing in nature suggests that life is formless. If life has form, then it is a logical assumption that economics (which is a form of life) have form as well.”
A. Hamilton Bolton
BEFORE EMBARKING ON a study of any of the technical tools of stock market behaviour one must accept some basic truths of the stock market itself. Failure to accept the truth of stock market action will result in a failure to comprehend the rationale for the methods being used, which in turn will result in a lack of confidence and, in all probability, an inconsistent approach to the method. There is nothing worse than a student of stock market behaviour who suddenly places all his faith in a particular tool, finds the tool lets him down on the odd occasion, then switches to another tool, and so on and so forth, until the results he achieves are totally random. The secret to stock market success is to find a tool with a high probability of success, stick with that tool and above all, be consistent in your approach.
$2,000 to $1,000,000
During my lectures I often tell the story of my client in New York who parlayed a sum of 2,000 dollars, his life savings, into the sum of close to one million dollars. He had no extraordinary formula. He wasn’t a dancer who pirouetted his way around the world with a “box system”. All he did was place his total funds in the stock market whenever the yield on the Dow-Jones Industrial Averages rose to above 6 per cent. When the yield in the Dow-Jones Industrial Averages fell below 3 per cent he took all his money out of the stock market and put it in a savings account. He left his money in the savings account until the yield on the Dow-Jones Industrial Averages rose to above 6 per cent and then began the process all over again. Nothing could be simpler.
He had mastered three important principles: that of being inactive over long periods, that of consistency of approach, and the recognition of a high success-ratio criterion. Compound interest did the rest. He was a long term investor and it took him over 30 years to build his fortune. However, his method should provide an example. Even better results can be achieved with the Elliott Wave Principle if similar mental disciplines are applied.
My client was relying on the long term cyclical repetition of the yield factor. He wasn’t particularly concerned with the time frame aspect, but merely the cyclical yield pattern. A theory based on cyclical repetition will always appear somewhat strange to those versed in the traditional approach to the socio-economic-world-of-finance type problems. The economy looks gloomy so we steer clear of the stock market. The economy looks bright so we are encouraged to participate in the stock market which will supposedly reflect the economic growth of the nation. A company turns in good results so we buy the shares of that company. All of this seems to be a perfectly logical approach but for some reason, share prices have a tendency to fall after a company turns in good profits. Furthermore, it is a fact that when the economies of various countries look their most promising, the stock market is usually on the brink of a disastrous decline.
The Future not the Past
There are reasons for this basic fact of stock market life. The stock market deals with the future not the past. Information that appears in today’s newspapers is a report of events that have already occurred. According to the work of the academics who have studied behavioural patterns in the stock market relative to the dissemination of news, the stock market is totally efficient, and such is the speed of communication that there is no advantage whatever to be gained by acting on material which has been published for mass consumption.
Variations in share prices are the factors that lead to stock market profits, and the major turning points in the stock market are rarely confirmed by corporate earnings or the trend of business. If we examine a typical cycle, applying a basic Elliott Wave classification, we can see how this works.
As mentioned in the previous chapter, according to the wave principle, each bull cycle consists of three upward movements and two downward movements. Let’s take a look at the London Stock Market over the past 12 months (see Figure 2).
Figure 2. F.T. 30. JAN 1975-FEB 1976
In January 1975, the U.K. economy was looking disastrous and the newspapers were printing a steady barrage of doom and gloom. But, as if by magic, following the announcement of the Burmah Oil crisis, in early January share prices started to rise. Not only did they rise but they virtually exploded. Very few members of the investment community believed in the rise and there certainly was a complete absence of any fundamental support for the rise. It was not until later in the cycle, after the stock market had almost doubled, that many began to find reasons for the move… after the fact of course. By June of 1975 the stock market had risen from the January low of F.T.30 146.5 to a peak of F.T.30 368. Since many felt there was little improvement in the economy over the entire period of the stock market ebullient advance, the only reason they could find for such a rise was that Britain was heading for hyper-inflation. Recollections of the manner in which the German Stock Market rose by 30 billion times its base level during the German hyper-inflation raced through the stock market. Just about the time this a priori judgement was receiving general acceptance, the market was beginning its first intermediate decline. Between January 1975 and June 1975, the British Stock Market completed the first Wave of what will subsequently be a five-Wave primary cycle. The second of the five waves began in June 1975 under the growing belief that the bear market was returning once again. By August 1975, the British investment community was forecasting a return to the lows of the previous bear market, and even lower. However, share prices began to rise again as the British Stock Market began “Wave 3” of its primary cycle, having complete Wave 2, the corrective down-wave according to Elliott.
1976 brought cheer to the investment community in Britain. The month of January produced a plethora of economic forecasts which pointed to a revival in the economy. Lead economic indicators were said to be turning up. Relations with the trade unions were improving. Share prices on Wall Street were doing well and all in all, a more bullish atmosphere couldn’t be found. Fund managers were quickly reducing liquidity positions and the private investor began nibbling at shares once again. Finally, after 12 months of rising share prices, the investment community discovered the reason. There was about to be a brand new export-led growth in the British economy. In response to the