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      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