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Nothing Random on this Walk


Market declines too frequent to support theory.

It's been a little more than 6 months since I wrote Riding the Elliott Wave, where I proposed that the market was poised for prolonged slide based on my detailed count confirmation of an Elliott Wave thesis that Robert Prechter had proposed after the market rallied back from his theory in the 1990s, that 2000 was the top of a 5-count impulse wave that started in 1932 (The Super Cycle).

He proposed that his theory from the 90s was still correct, and that we were in the midst of a corrective flat. Following an in-depth study of his published works, I attempted to validate his thesis with the following detailed wave count of a probable corrective flat following the 5th wave high in 2000.

Click to enlarge

Following the article, my mailbox was littered with ridicule from believers of the Random Walk Theory (the vast majority).

However, with the subsequent watershed down in the markets, I have noticed a flurry of renewed interest in the Elliott Wave Principle on Minyanville and elsewhere. Here's a chart (minus the detailed labels) filling in actual price action since I wrote the article in April.

Click to enlarge

Can I predict the future? No. Did I just get really lucky? No. I am applying probability based on Fibonacci mathematics and Elliott wave structure and behavior first theorized by Ralph Nelson Elliott in 1938 and rescued from the dust bin of history by Robert Prechter Jr. in the 1960s.

Since my analysis and trading focus is primarily short-term, I offered several alternate theses for the market to turn back up during the course of this plunge to both subscribers of Buzz & Banter and

However, price continued to follow the script of the longer-term corrective flat thesis in an uncanny, arguably, deterministic manner, and it still does today. By combining the top-down analysis I did in April (above) and extrapolating the shorter term price movements in bottom-up analysis (daily and intra-day), I am now able to construct a probable pattern for the end game of the five wave set of Wave C down from the October 2007 high.

Here it is projected on a weekly chart.

Click to enlarge

The above thesis assumes that price will not go higher than the high today. If it does, then I will adjust the forecast with the new price information. It's a lot like trying to predict the landfall of a hurricane.

But how could I possibly do this if markets are random?

Random Walk theory states that price essentially follows a normal distribution curve that looks a lot like a common bell-shaped curve. When price has an extreme deviation from this normal distribution, it's called a "fat tail." According to Random Walk Theory fat tails are rare. They have to be rare because they represent outliers over the course of a normal distribution curve. If they weren't rare, then statistically, the market data couldn't be random.

If successive declines occur more often then statistically predicted, then a correlation must exist - and the markets do not follow a random walk. Research performed by Didier Sornette in 2003 showed that the market declines of 1914, 1929 and 1987 alone were too frequent to support the Random Walk Theory. He calculated that about 50 centuries should have separated crashes of that magnitude.

Now we can add 2000 and 2008 to the statistics. Do you still want to bet on that Random Walk?
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No positions in stocks mentioned.

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