Today's guest post is from our friends at the Benzinga News Desk. Today they are going to ponder the age old question of fundamental or technical analysis and discuss the Elliot Wave Principle. Be sure to comment below with your own thoughts and learn more about the Benzinga News Desk here.
Investors and traders have been arguing for the longest time about which overarching strategy is king: fundamental analysis or technical analysis. Long-term investors believe that technical analysis is trash and nothing more than lucky betting, while short-term traders think that fundamental aspects of companies and economies do not matter for short-term price movement.
The reality is that both techniques are useful; fundamental analysis can help you determine which equity is a good investment while technical analysis can help you figure out the entry and exit points.
An interesting technical analysis indicator that attempts to predict market psychology, and more importantly, market movements, is called the Elliott Wave Principle. The indicator, developed by Nelson Elliott, was created to track collective investor psychology.
The model proposed by Elliott is based impulse buying and selling, and purports that human reaction tends to be very repetitive. The basic structure of the Elliott Wave's in context of the market looks like.
The top pattern is how the trend generally works when Elliott Waves are triggered. However, no stock moves straight up or down, there are always minor aberrations when stocks move.
Based on mathematic patterns called fractals, Elliott determined that each leg up and down are composed of smaller Elliott Wave patterns, complete with the 5 legs in the upward trend and 3 legs in the downward trend. The Elliott Wave principle became especially famous in the 1970s when Robert Prechter predicted the stock market crash in 1987. Since then, thousands of traders have relied on the patterns to determine macroeconomic trends.
The Elliott Wave theory can be applied to many real-life situations. Looking at a chart of the 2008-2009 crisis, it is easy to see how weekly analysis of trends in the S&P 500 could have predict downward movement. From point 1 to point 2, we see a large move upwards. However, after point 2, the move downward is clearly seen. Even looking at smaller time frames, like daily charts, can help day-traders make moves in between weeks, as point out by the small, red numbers. In all practical senses, the Elliott Wave indicator can be applied to various time frames, and can be used by day-traders and long-term investors alike.
Understanding what is happening to the greater economy is more important now than it has ever been. It is extremely important for traders to be able to figure out when the market is going to trade upwards or downwards, and Elliott Wave analysis may be an appropriate indicator. It is important to make sure that the theory fits with your trading style and makes sense to you; otherwise, it will never work out.