Q: If the Elliott Wave Theory is so good, how come after 86 (?) years, it’s not being used by everyone?
A: That’s a really good question with many answers attached. I’ll start out by saying that technical analysis fills a small niche within the investment community. And if you focus in on just TA alone, Elliott Wave Theory ultimately becomes a niche within a niche.
It is but one of many approaches to investing. And while its popularity has taken off and garnered more attention over the past decade, in part due to the development of advanced charting software, the majority of the investing public sticks to valuation and making decisions based on a particular company’s story, forward looking earnings estimates and/or products and services.
I believe there are a few reasons why this is the case. In the past, and in some circles today, the trade is seen as a voodoo practice. But the answer for me becomes one of competence and passion. The truth is that it takes time and continual application to develop an eye for buy and sell signals. Many are lazy and simply do not put in the necessary effort to master all that goes into this unique field. As such, these so-called “experts” see false signals and create nothing but doubt for those who follow their lead.
There’s a generally standard formula for equity valuation which involves a small bit of flexibility. Make a mistake and you’re more likely to be in the ballpark of what the fair value of a given stock might be. With technical analysis, there is little forgiveness in error. One slip and it could backfire badly.
Q: The world’s greatest investors like Warren Buffett never mention anything about technical analysis? Are you saying you’re better than Warren Buffett?
A: When I read the question I immediately thought that it was an apples-to-oranges type of comparison. I’m not in the business of owning, buying and selling companies. I don’t think it’s a matter of who is better because we do not compete in the same space. Buffett is the ultimate insider who has a fundamental approach and needs to park his vast amount of capital in many operations around the globe. To put it simply, there are many angles to profits in this game and he has mastered his – just as I have continually pushed to master mine. Technical analysis happens to be a different beast altogether and should be treated as such.
Q: If the stock market’s moves are random, how can past patterns be any indicator at all of the future?
A: That is what the majority of people out there would have you believe. There are many predictable patterns which tend to be on display with regards to social principles and their relationship with price moves in the market. But if you have no knowledge of what Ralph Nelson Elliott discovered almost a hundred years ago, it is understandable that one would see all market activity through a random lens.
Elliott observed these patterns and developed a set of rules to validate wave counts. Get the wave count right and you’ve armed yourself with the knowledge that is on par with being a fly on the wall of a company’s board of directors. While you may not know what the specific news and catalysts are for price movement, you will be able to predict with a high degree of certainty where things are heading and how and set profit targets accordingly.
Q: Is this like those CD sets on the late night infomercials that promise instant riches?
A: No, this isn’t some get rich quick scheme or system built on fluff. It’s a legitimate tool analysts use to analyze market momentum, trends, psychology, etc. Fundamental analysis focuses more on proper equity valuation in an attempt to find value where it is not yet priced in. The only problem is that you can literally hold on to a stock for five years before seeing a return on your investment. I don’t know about you, but I’m not in the market to waste precious time. So in comparison, technical analysis seeks to determine when a stock or index will change course and how long that price run is likely to last.
Q: How is technical analysis and buying and selling individual stocks better than an ETF?
A: I’d say they each have their own purpose. ETFs generally aim to provide liquidity in a low transaction fee environment to allow investors to make painless changes in the makeup of their retirement portfolios. They represent a solution where mutual funds of old fall short with management teams who attempt to outperform their benchmarks consistently without taking on too much risk to achieve the objectives in the space they compete in.
On the other hand, if you are investing out of an individual investment account with capital you can afford to do without, then perhaps buying/selling individual stocks would be better for you. It’s certainly one way to record profits up and beyond what an ETF can do.
Using technical analysis when investing in stocks allows you to maximize profits (especially when playing the options) in the shortest reasonable time possible. But again, you have to know what you’re doing to profit consistently. Otherwise, you’d need to hire a competently expensive financial analyst to provide actionable ideas born of proper research and analysis. Although not all are made equal, affordable investment newsletters exist to solve this problem.
Q: I’ve made a lot of money in the last 5 years in stocks on my own. Why would I need the help of technical analysis now?
A: That’s great, but what if you can do better? I would imagine it difficult to find someone who refused to become wealthier than they are now. As an investor myself, I’ve been pleasantly surprised over the years to find that the learnings process never ends. Just when you think you’ve got it all figured out, something comes along to challenge that mindset.
Let’s say you’re winning trade percentage is 70%. Can you improve on that number and how much time and effort did it take to get there in the first place? How many trades did you perform throughout the year? Are you seeing many small gains or large ones? What is the degree of consistency and did you use stop losses to help remove the emotional side of investing from the equation. These are just a few of many factors that go into determining investment failure and success. At the end of the day, there’s little incentive to become complacent in the marketplace.
Q: I see expensive trading software offers to plot Elliott Waves on any stock or index. Why would investors not use this instead?
A: There is a significant delay in software when it comes to mapping out the Elliott Wave count. Additionally, it doesn’t factor in other technical tools which can help strengthen what the wave structure is telling us. For example, I love to use the Moving Average Convergence Divergence (MACD) and Directional Movement Index (DMI) indicators to measure momentum and trend strength and help maximize profit potential. At best, the software can only confirm we’re on the right track with regards to the wave count. So there’s an incredible amount of value placed on the human element, assuming there are no concerns with experience and competency.
Q: What would you advise someone who is new and has a desire to learn and follow along?
A: I’d say read as much as you can on technical analysis so that you form a solid foundation. This includes understanding topics like indicators, candlestick charting, pattern recognition, Elliott wave, etc. After a while, things begin to sink in. Then you can paper trade until your experience grows to a point where you feel comfortable throwing real money into trades. The best part of my newsletter the Reflex Momentum Report is that you’ll have a hand to guide you and provides solid picks in the process.
Q: What’s your favorite book on technical analysis?
A: Thomas Bulkowski’s Encyclopedia of Chart Patterns is an excellent resource when it comes to refreshing your memory on patterns and ideas how to play them. The book also reviews the historical success rates under various scenarios which when determining how reliable breakouts or breakdowns will be.
Q: Are there any free charting sites out there you would recommend your readers?
A: In the past, I remember Bigcharts.com and Stockcharts.com being the two main free resources for investors to use. But limited functionality and lack of software improvement left investors wanting more.
Then Tradingview.com came along. It’s a complimentary service which allows you to create and save a column of all the equities and indices you follow. Investors can plot just about every technical indicator in existence. And I make frequent use of their easy to use annotation tools. If I draw e-waves or support/resistance points on a stock chart, that work will be saved the next time I log into my account.
P.S. Check out our comprehensive financial newsletter, Reflex Momentum Report. It uncovers “under the radar” investment opportunities, marrying fundamental quality with critically important technical timing to enhance potential returns.