Posts Tagged ‘Educational Material’
Streaming Seminar Breaks Down “Greeks”
No matter what the investment, an investor needs to know and fully understand the potential risks of the investment prior to committing capital to that investment. In the options market, the Greeks define and quantify the risks of your position before you commit to the investment. Understanding the Greeks is a must for proper risk management. Further, the Greeks can also help you identify and select not only the proper strategy to fit the opportunity you selected, but also which specific options to use to create that specific strategy.
Today you need to watch this complimentary seminar covering the Greeks…
http://www.ino.com/info/36/CD3336/&dp=0&l=0&campaignid=9
Without a full understanding of the risks of an investment, an investor should never commit hard earned money. If you do not know your Greeks, you have no business being in the options market!
Good luck to you all!
Alan
Q&A With Robert Prechter: Why Technical Analysis Beats Out Fundamental Analysis
By Elliott Wave International
As the major stock markets turned down in late 2007 and then started to rally in March 2009, many people who believed in fundamental analysis have begun to question its validity.
Famed technical analyst and Elliott wave expert Robert Prechter has long called for the bear market we are now in the midst of. (He views the rally of 2009 to be a bear-market rally not the beginning of a new bull market.) But over the years, his methods of technical analysis have been criticized. Here are his most succinct arguments as to why wave analysis outdoes competing forms of analysis.
Learn the Wave Principle and Other Forms of Technical Analysis. Elliott Wave International has just released The Ultimate Technical Analysis Handbook. This FREE 50-page ebook is dedicated solely to teaching reformed fundamentals followers to incorporate technical analysis into their own investing decisions. Learn more and download your free copy here.
*****
Excerpted from Prechter’s Perspective, re-issued 2004
Question: Suppose everyone agreed, “The Wave Principle is not always right, but it really is the answer”?
Robert Prechter: Well, let me begin my answer with a quote from a national financial magazine dated October 1977. “Over the last few years, the Wave Principle has gathered too much of a following and, therefore, it has less value today. Almost invariably, you can write off a technique when it gets too much of a following.” How does this statement look in light of the decade that followed it? “Elliott” had one of its greatest successes. Like the Energizer Bunny, it keeps going and going. And I believe its next success will be its biggest ever. The Principle itself is undoubtedly on an upward spiral of acceptance: three steps forward and two steps back.
Now let’s suppose that a large number of educated people accepted the Wave Principle, which is not an impossible idea for, say, a thousand years from now. There would still be room for differences of opinion on the market and the future. And there are countless other factors. Even people who practice the craft don’t necessarily take action when they get a signal. Unconscious doubt and worry often foil people’s actions. Very few traders have the emotional strength to turn even good analysis into profits.
Q: The Wave Principle is intrinsically contrarian. Does it have some built-in defense against becoming the consensus?
RP: I think so. The Wave Principle is a description of natural human behavior. This is what human beings are; this is part of their nature — how they behave. In order for markets to continue to go through these stages, a part of human nature must be to believe that such theories of mass psychology are incapable of being true — that is, something not worth examining. They must be primed to accept bullish arguments at tops and bearish arguments at bottoms. That means they have to be ever open to bogus theories of market behavior. How else will they create the patterns that fear, greed and hope produce?
Q: How big is the pool of analysts who rely on the Wave Principle?
RP: I think there are quite a few people who are proficient in applying Elliott to past and present markets, say, perhaps 1% of all technical analysts, which is a pretty good number of people, I suppose. A lot of those are my subscribers, and they learned it through studying the Theorist. However, as far as the number of people proficient at applying the Wave Principle for forecasting market turns, which is significantly more difficult than applying it in real time, I think there are very few.
Q: This has been the basis of some criticism. To quote one critic, “relying on arcane methods does have one advantage. Interpreting the linear squiggles is left in the hands of the major heir to Elliott’s work.” How do you respond to those who contend that the complexity of the theory is a cover that allows you to retain the Wave Principle as your personal theory?
RP: With regard to any supposed self-serving secrecy, not only did I co-author a book on how to apply the Wave Principle, as well as reprint Elliott’s writings against protest from practitioners, but also I continually go into great — some might say excruciating — detail in each issue of The Elliott Wave Theorist explaining exactly what I think the market has done and will do, and why I think it. If there is any market letter that has educated potential competitors, it is mine. The reason is that the study of markets is more important to me than exclusivity, secrecy or power.
Q: Another common approach critics take when they try to dismiss Elliott as bunk is to refer to you as a mystic or a numerologist.
RP: A mystic believe in things for which there is no evidence, only desire. I do not consider myself to be a mystic at all. My approach is objective. The empirical basis of Elliott’s discovery speaks to that fact. So do the results of the trading competition [Editor's note: Bob Prechter won the Trading Championship in options in 1984 with a stunning 444% gain. The next closest competitor showed an 84% gain.] Not once during any month since the independent rating services have been following market timers has a timer using a numerological approach such as “Gann” analysis ever placed in the top 10 rankings. Just as would be expected, such methods don’t work!
The true mystics are those who believe, for instance, that current economic performance is a basis upon which to predict stock market prices. There is no evidence for it. They just feel comfortable with the idea, so they espouse it.
Q: So you say that the challenge to validity is on the other side?
RP: You’re darn right, it is. I am no longer at the point where I feel that I have to justify the objectivity of the Wave Principle. I think the results have done that. Technical analysis is entirely rational and has proved itself. If someone goes back and looks at the record of Elliott wave writers over the decades, he will find a track record of forecasting success that is well beyond a random result of chance. If you can do that, the ball is in the other guy’s court. It’s up to him to show that this is luck or something. What’s more, the only challenge to a theory is a better theory, and I haven’t seen a contender yet.
Q: You don’t feel that you have been effectively challenged by any fundamental approaches?
RP: I think there’s a place for fundamental analysis of individual companies, but I am firmly convinced that you can make a very rational argument showing that fundamental analysis applied to overall market timing is like reading the entrails of goats. In fact, I presented such a critique in The Wave Principle of Human Social Behavior. If you think my ideas as presented here are controversial, just read Chapter 19 of that book.
Learn the Wave Principle and Other Forms of Technical Analysis. Elliott Wave International has just released The Ultimate Technical Analysis Handbook. This FREE 50-page ebook is dedicated solely to teaching reformed fundamentals followers to incorporate technical analysis into their own investing decisions. Learn more and download your free copy here.
Robert Prechter, Chartered Market Technician, is the world’s foremost expert on and proponent of the deflationary scenario. Prechter is the founder and CEO of Elliott Wave International, author of Wall Street best-sellers Conquer the Crash and Elliott Wave Principle and editor of The Elliott Wave Theorist monthly market letter since 1979.
Why ETNs are Riskier Than They Look
by Ron Rowland
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| Co-editor of Weiss Research’s International ETF Trader |
Mike Larson is off today, so he asked me to fill in for him. And one thing that I think Mike and I both agree on is that ETFs, or exchange traded funds, are one of the best things that ever happened for small investors.
You may already know about the advantages they have over conventional mutual funds … liquidity, low costs, transparency, diversification, and more.
What you may not know is that there is a new investment that looks a lot like an ETF but is actually a whole different species. I’m talking about ETNs: exchange traded notes.
On the surface, ETNs share many of the characteristics of ETFs. You can buy and sell them on the stock exchange throughout the day, their performance closely mirrors an index, and they give you access to specialized market niches like commodities and currencies.
However,
There is One Gigantic Difference …
An ETN Is Really a Bond!
That’s why they’re called “notes” rather than “funds.” Yet it usually doesn’t pay interest at a fixed rate, like say a Treasury bond would. Instead your “interest” is the return on a designated index.
Let’s look at an example:
The iPath S&P GSCI Crude Oil ETN (OIL) is very popular right now. It’s designed to track the return of a crude oil price index. This gives you a way to participate in the crude oil market without using more complicated and risky tools like futures.
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| When you buy the OIL ETN you’re not buying oil. You’re buying a promise from the issuer to pay you some date in the future. |
When you buy the OIL ETN, are you actually buying oil? No, you’re not. What you are buying is a promise from the issuer — British banking giant Barclays, the corporate parent of iPath — to pay you a return linked to the performance of the Goldman Sachs Crude Oil Return Index at some date in the future.
So with OIL you don’t get any oil, directly or indirectly. All you get is a promise from Barclays Bank that you’ll be repaid when the ETN matures, with no claim on any particular assets. You are now an unsecured creditor of Barclays.
This brings up another question: What guarantee do you have that Barclays Bank will be around to make good on its promise? Answer: none.
If Barclays should fail for any reason — even something completely unrelated to this particular ETN — the promise you bought could go up in smoke. You’ll be just another creditor when the bankruptcy court divides up whatever is left of Barclays.
Now compare this to an ETF …
In the U.S., ETFs are regulated under the Investment Company Act of 1940. They are chartered as separate corporations. The ETF’s board of directors hires a manager to keep things going and you, as an investor, own shares of the corporation.
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| Before Lehman Brothers went belly up, it launched three ETNs in early 2008. All three have bit the dust. |
If the manager of an ETF goes bankrupt, what happens to the assets of the ETF? Nothing. There might be a temporary disruption while the board finds a new manager, but the underlying stocks, bonds or other instruments in the fund will be secure. Not so with an ETN.
Think it can’t happen? It already has!
The now-defunct Lehman Brothers launched three ETNs in early 2008 under the “Opta” brand name. The ticker symbols were EOH, PPE and RAW. Look them up and you’ll find they aren’t around anymore.
When Lehman failed in September, owners of those three ETNs found themselves holding the short end of the stick. Now their money is tied up in one of the most complicated bankruptcy cases ever. It could be years before they get anything back, if ever.
There are other examples, too. Investors in a Bear Stearns-issued ETN narrowly escaped the same fate last year when that embattled company was taken over by JP Morgan Chase.
Even scarier, most of the major ETN issuers are not exactly as stable as the Rock of Gibraltar. Far from it. Going back to our Barclays example, BCS stock has been cut in half in just the last month.
Why? Analysts think Barclays is so shaky the U.K. government may have to nationalize it. The company has taken billions in write-downs on the same kind of toxic derivatives that are bringing down other large banks.
Just this week, Moody’s Investor Services downgraded Barclays debt — which includes all the iPath ETNs — to Aa3 from Aa1. Traders reacted by demanding wider bid-ask spreads on iPath ETNs, which means investors owning those ETNs could take a shellacking.
I’m not just picking on Barclays here. All the banks that issue ETNs are having similar problems. Other top ETN issuers include …
- Deutsche Bank (DB)
- Morgan Stanley (MS)
- Goldman Sachs (GS)
- Swedish Export Credit Corp (FUE)
- HSBC Bank (HBC)
Would you loan your money to any of these companies? That’s exactly what you are doing when you buy their ETNs! Yet most of them are so weak they’ve had to be bailed out by the government and/or the Federal Reserve in the last few months.
Am I Saying You Should
Always Avoid ETNs?
No. I believe that they can provide a way to trade in markets that are hard to access otherwise. What I’m saying is that you need to understand the risk you are taking before you buy.
Sadly, many investors have no idea that they are accepting this kind of credit risk when they buy an ETN. They think it is just a new kind of mutual fund. They don’t know they can lose their money even if their market predictions are totally accurate.
What’s even more infuriating is that the ETN issuers don’t always go out of their way to let people know the difference between ETFs and ETNs. Barclays at least had the good sense to market their ETFs and ETNs under two different names: iShares = ETFs; iPath = ETNs.
Other companies leave it up to you to know what you’re buying. You see “PowerShares” in the name and assume you are buying an ETF. Not so — some ETNs carry the PowerShares name.
Nor is it clear which bank is behind which ETN — sometimes it varies even within the same ETN family. So you have to dig through the prospectus to find out exactly who is getting your money.
Even Morningstar, the very pillar of unbiased fund data, lumps ETFs and ETNs into the same category in their database. Worse, they don’t always include “ETN” in the fund names.
What Should You Do?
I suggest avoiding ETNs completely if there is a very similar ETF available. And if you do buy an ETN, make sure you aren’t exposing too much of your portfolio to any one ETN sponsor — and keep an eye on the issuing companies.
Right now there are roughly 87 ETNs available to U.S. investors. I don’t have enough space to list them all here, but I’m giving you a list below that shows some of the larger ones. Refer to this list — and know what you’re buying.
TOP 10 ETNs by Assets as of 12/31/08 |
iPath DJ-AIG Commodity Index Total Return (DJP) |
PowerShares DB Crude Oil Double Long (DXO) |
iPath MSCI India Index (INP) |
PowerShares DB Gold Double Long (DGP) |
iPath S&P GSCI Crude Oil (OIL) |
ELEMENTS Rogers Agriculture (RJA) |
Market Vectors 2X Short Euro (DRR) |
Goldman Sachs Connect S&P GSCI (GSC) |
ELEMENTS Rogers Total Commodity (RJI) |
iPath DJ-AIG Livestock (COW) |
Best wishes,
Ron
These Three Charts Will Save You A Fortune
Russell Napier, a well-known stock market historian, studied market tops and bottoms over the last 100 years and showed corporate bonds tend to lead the stock market by several months at important turning points.
When this bond fund starts falling, you should exit the stock market, but until then, you have a green light to speculate…
LQD has turned lower in the last four trading sessions. Please keep an eye on this chart. If it breaks below 103, immediately exit the stock market. A large decline may be imminent.
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LQD isn’t the only indicator I follow to track the health of the market. I also watch the British pound…
The British pound is one of the most important financial indicators in the world. Britain was at the epicenter of the credit crisis. It had a huge housing and mortgage bubble… even bigger than the housing bubble in the U.S. Britain also had a huge banking and finance bubble. In this bubble, London became the world’s largest financial center. Finance represents almost 10% of Britain’s GDP.
In other words, the pound is the perfect symbol for housing and financial excess. When the pound is rising, it means the pain is subsiding and the storm clouds are breaking. When the pound is falling, financial misery is increasing.
Here’s the chart of the pound. On Friday, the pound broke down to new four-month lows.
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Here’s another bearish development. Commodities are falling in terms of gold…
Gold is a safe haven. People turn to gold when they’re afraid of financial chaos. But when they’re optimistic, people use more energy, eat more food, and live in bigger houses. These activities require industrial commodities like oil, copper, aluminum, and corn.
So the relationship between gold and industrial commodities is an excellent barometer of fear and greed in the stock market. When commodities fall against gold, there’s fear in the air. But when they rise against gold, people are growing optimistic.
This chart shows the price of gold set against the CRB Index of commodities. This barometer led the stock market by three weeks in March, when the bull market started.
In September, the commodity-gold ratio broke down to a new four-month low. It hasn’t made a new low for three weeks. But watch this one. There may be misery coming in the stock market if it makes a new low…
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If you invest in the stock market, you need to follow the performance of these three charts. They’re among the best gauges of fear and greed in the market. As their prices go, so goes the stock market.
Right now, these charts are hinting at a new downtrend. My advice, hold off on making new buys, cut your most risky positions, and tighten your stop losses.
– Tom Dyson
Contributing Editor
Daily Wealth
Fractional Reserve Banking Made Easy
By: Terence Gillespie
The paper bills in our wallet are not money. And they are not Notes as in “Federal Reserve Note” written on the top of the bill. They are actually just Tokens. Federal Reserve Tokens, if you like, is what should be written on top of the bills. They are not redeemable for anything other than themselves. And they represent only one thing: Your belief in their value. Hopefully, your belief extends to the next person you try to give them to.
The only real use for them is paying your taxes to either the state or federal government. You can be sure, however, that both will stop accepting them as payment even for taxes if you and I stop believing in the paper bills.
Paper money, or fiat, was originally accepted because you could redeem the paper for gold upon request. When people got used to the paper they felt more and more comfortable and were less likely to redeem it for their gold. They knew that they could redeem it at any time and the paper is lighter, more convenient and can be denominated in much smaller increments so that everyday transactions are made more practical.
By the time the gold imparts this trust to the paper the people storing the gold start using it for other purposes. The primary other purpose is to start using the gold as someone else’s money in addition to yours. When that happens the banker has now, in effect, doubled the amount of gold in his vault and is only in trouble if you decide to reclaim your gold. By that time many more people are storing their gold with the banker and he found that only a small percentage of people ever reclaimed their gold.
Now, at this point in the story nothing wrong has happened as long as:
- You are told that your gold deposit is being lent out.
- You are paid for storing your gold.
- Your are not charged under the guise of a storage fee because the gold is no longer being stored by the banker.
- There is a 1-to-1 relationship between the gold you lent the banker and the gold the banker has lent out.
Christians do not believe in charging interest to other Christians. But, even the Bible describes the business of lending while warning that “The borrower is a slave of the lender.”
In the business of lending the difference between what you receive for the use of your gold and what the banker receives for lending it out is his legitimate profit. After all, if you don’t want the banker to lend it out then you can lend it out yourself and do all the work associated. More importantly, the gold is not taken out of circulation and can be used as legitimate capital for the borrower to invest in his ideas to create even more value for everyone.
As you might suspect, this is not how the story goes.
When the number of people who were likely to reclaim their gold was discovered then the banker could start to guess the amount of gold to keep on hand to make all his depositors believe he was storing their gold. This number becomes his required reserve ratio and fractional reserve banking is born.
The banker has used a combination of your gold, your trust in him and your infrequent need to reclaim your gold to pretend he has many times more money than the amount of gold that is actually stored with him. And since he is most likely not fulfilling the four requirements, above, he is probably charging you a storage fee, not paying you, not telling you he’s lent it out and is lending out much more gold than his depositors have deposited.
Even worse, the banker lends out gold that doesn’t exist and charges interest on the loan. The banker is now generating interest income on gold that he doesn’t have and that doesn’t exist. Fractional reserve lending is born. Here’s a video that describes how money is loaned into existence in today’s world. Start at 22:00 if you want to skip right to it:
There are three major problems with fractional reserve lending. The first problem is when the banker lends money that doesn’t exist to people who then use that money to purchase real goods then the money actually does now exist. The banker has loaned into existence new currency. The banker used to have to at least go to the trouble of printing up the actual paper bills. But, with computers he can even bypass that unpleasant task. This would be impossible if the banker had to attempt to fabricate the actual gold.
And that leads to the second major problem with fractional reserve lending: There is no longer any gold in the bankers vault. The “money” is just blips on a computer screen that can be typed in and deleted, as needed, to adhere to an extremely low, but legal, reserve requirement.
The third major problem with fractional reserve lending is that most of the deposits don’t come from people who received the money by creating real value. The majority of the deposits come from other loans that came from either the Federal government or the loaned out portion of another fractional reserve lending bank.
This leads back to the original point of this article: There is nothing backing the paper bills in our wallet but our belief in them. They are mere tokens redeemable for nothing and backed by nothing.
Although it may be convenient for the US, and the entire world, to continue believing in the US dollar there is actually no historical basis for the success of any fiat currency. That’s because no fiat currency has EVER survived in the history of the world. You read that correctly: It’s not a matter of studying the good ones and seeing what they did right or wrong to make them succeed. None of them has ever survived.
Since the probability of any paper fiat currency collapsing is 100% then we can switch our focus on trying to guess when, not if it will fail.
For more on Fractional Reserve Banking and Lending and the history of many currencies around the world check out Larry Parks on YouTube or go to his website.
Terence Gillespie [send him mail] has worked at IBM, played jazz piano on cruise ships, is an instrument rated pilot, songwriter, and is attempting to optimize every aspect of life one article at a time on his blog at YourOptimal.com.
Copyright © 2009 by LewRockwell.com. Permission to reprint in whole or in part is gladly granted, provided full credit is given.
Get Your Free 50-Page Download: The Ultimate Technical Analysis Handbook
Today more and more investors are warming to the fact that psychology moves markets and therefore fundamental analysis, which fails to properly measure mass investor psychology, must be flawed.
Who can blame them? After all, fundamental analysis — based on past company earnings, rating agency projections and the like — proved to be of little value during the bust.
There is a better way.
Many investors who monitor investor sentiment readings, study Elliott wave patterns and employ other powerful technical indicators were — at very least — able to position themselves to survive the recent decline. Still others were able to turn crisis into opportunity and profit from the volatility.
How’d they do it?
Technical analysis.
You see, technical indicators remove the cloudy, bias-driven assumptions from your analysis and focus on the one thing that moves markets: investor psychology.
Past performance is not indicative of future results — and that’s where fundamental analysis goes wrong. It fails to factor in the psychology that not only moves markets up and down but also leads analysts to extrapolate the current or past trend into the future. That’s why fundamental analysts almost always miss major tops and bottoms.
Our friends over at Elliott Wave International employ the largest team of technical analysts in the world. They recognize that optimism peaks before market tops and pessimism troughs before market bottoms. They use powerful and sometimes unconventional tools to help identify psychological extremes that signal high-probability turning points.
EWI’s brand-new 50-page eBook, The Ultimate Technical Analysis Handbook, will show you the various methods of technical analysis they use every day and teach you how to use these powerful tools for yourself.
If you’re a technician, this eBook is perfect for you. If you’re a fundamentals follower, it’s more important than ever that you give technical analysis a closer look. Even if you never completely abandoned your fundamental indicators, you WILL benefit from drawing on these valuable technical tools.
Learn more about this free eBook, and download your copy here.
Inside deal gets you $691 in Forex bonuses
(Due to an ‘inside deal’, you might
still have a chance to get in on this
sold-out Forex training… PLUS keep
$691 in bonuses, even if you send it
back!)
Last week, 35+ year trader Bill Poulos quickly burned
through his initial inventory of his brand new Forex Time
Machine training course…
This course was then pulled off the market last Thursday
(the countdown timer flashed “Sorry, Expired” at 11:59pm
that evening).
===> GOOD NEWS FOLLOWS…
Then, over the weekend, Bill made an ‘inside deal’ with his
private ‘priority list’. They helped him figure out what
kind of extra training to add for his next group of students
by filling out a survey; and in return, Bill agreed to
release 75 more copies of his course.
But he also did something a little crazy for them –
– he added on $691 in previously-unannounced surprise bonus
training materials.
(And he’s letting them KEEP the bonuses even if they end up
returning his new course!)
When I found out about this, I asked Bill if I could get you
in on the deal.
He agreed, but with one “catch” — he’s not planning on
producing any more than the extra 75 copies he churned out
over the weekend.
===> BAD NEWS BELOW…
The bad news is that his ‘priority list’ already snapped up
almost half of these remaining copies.
Further, even if there are any remaining, he’s pulling
everything off the market this Thursday, September 24th, at
11:59pm Eastern.
As of this writing, he shows 39 copies left…
So it’s either 39 copies or a few more days – whichever
comes first.
Here’s the special link he set up for his ‘priority list’:
http://www.yourforexangle.com/y/?i=773362&u=4&l=f16
Good Trading,
Alan
p.s. If you’re still not where you feel you deserve to be at
with your Forex trading goals, I really hope this message
gets to you in time before this special deal expires. It’s
truly ‘top tier’ Forex education unlike anything you’ve seen
before, and it deserves a solid look… ESPECIALLY with the
“You Get To Keep ‘Em” $691 in bonuses here:
Dive into Elliott Wave International’s FreeWeek Now!
Greetings,
Our friends at Elliott Wave International have just announced the beginning of their wildly popular FreeWeek event, where they throw open the doors to some of their most popular paid services to non-subscribers for one week only.
For the first time ever, EWI is providing complete access to The Asian-Pacific Short Term Update and The European Short Term Update, but only until Sept. 23.
Markets move fast, so having an independent forecasting and near-term opportunity-spotting service on your side is more important now than ever. FreeWeek lets you see for yourself, and each day for one full week will show you clearly labeled price charts with updated analysis of all the major equity markets in the European and Asian-Pacific regions.
If you’re not taking part in EWI’s Asian-Pacific and European Short Term Update FreeWeek right now, you’re already missing the valuable opportunities your peers are getting for free, and FreeWeek only lasts from now until noon Wednesday, September 23.
Warmest regards,
Alan
About the Publisher, Elliott Wave International
Founded in 1979 by Robert R. Prechter Jr., Elliott Wave International (EWI) is the world’s largest market forecasting firm. Its staff of full-time analysts provides 24-hour-a-day market analysis to institutional and private around the world.
Free 47-Page eBook: How to Spot Trading Opportunities
Dear reader,
What if you could look at a chart and instead of seeing what happened, you could see the potential trading opportunities that could happen.
Elliott Wave International (EWI), the world’s largest market forecasting firm, has just released a free eBook to teach you exactly that.
The How to Spot Trading Opportunities eBook features 47-pages of easy-to-understand trading techniques that help you identify high-confidence trade setups. Senior EWI Analyst Jeffrey Kennedy will show you how some of the simplest rules and guidelines have some of the most powerful applications for trading.
Created from the $129 two-volume set of the same name, this valuable eBook is offered free until September 23, 2009
Don’t miss out on this rare opportunity to change the way you trade forever.
Warmest regards,
Alan
About the Publisher, Elliott Wave International
Founded in 1979 by Robert R. Prechter Jr., Elliott Wave International (EWI) is the world’s largest market forecasting firm. Its staff of full-time analysts provides 24-hour-a-day market analysis to institutional and private around the world.
Efficient Market Hypothesis: True “Villain” of the Financial Crisis?
By Robert Folsom
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.
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.
For more information from Robert Prechter, download a FREE 10-page issue of The 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.
Robert Folsom is a financial writer and editor for Elliott Wave International. He has covered politics, popular culture, economics and the financial markets for two decades, via print, radio and the Internet. Robert earned his degree in political science from Columbia University in 1985.
