There are many mistakes novice Elliott Wave analysts make. Not having learned the theory’s rules properly and not waiting for a clear pattern that meets them to form are the two most common ones. That’s where most of the frustration with Elliott Wave analysis comes from. When applied correctly, however, the results are good more often than not. The odds are further improved when the analysis is supported by fundamentals.
The chart below, for example, depicts a very clear Elliott Wave pattern in a company’s stock price at a very important time moment. We’ve deliberately not shown the name of the company, the time-frame of this chart and what year it was, because we’d like you to focus solely on the structure of the pattern.
Starting from the bottom left corner, we see a textbook five-wave impulse pattern, marked 1-2-3-4-5. The five sub-waves of wave 3 are visible, as well, and labeled i-ii-iii-iv-v. According to the Elliott Wave theory, a three-wave correction follows every impulse. So instead of extrapolating the uptrend into the future, an Elliottician would think that a notable decline makes sense first. Here is what happened next.
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The company was aerospace and defense contractor General Dynamics and the year was 2008. With the benefit of hindsight, we can now see that wave (2) developed as an expanding flat correction rather than a simple zigzag. But the point is that a clear pattern meeting all Elliott Wave rules was enough to warn us about the disaster ahead.
There were other ways, of course, like the high valuation of the general stock market. Or the inversion-un-inversion yield-curve recession warning. Or Michael Burry‘s understanding that the housing market was clearly in a bubble, whose collapse would leave nothing unscathed. Combining any of the above with Elliott Wave analysis would have strengthened one’s conviction to stay away from, in this case, General Dynamics.
2008 was long time ago, but some things don’t change.
Investors’ collective mood, for example, still produces Elliott Wave patterns. Seventeen years later now, we can see that the 2008 Financial Crisis was just the second wave of an even bigger impulse. We’ve marked it (1)-(2)-(3)-(4)-(5) and you can see that waves (3) and (5) also have clear five-wave structures. Wave (4) was unusually deep, because of the mass market panic, caused by Covid-19 in March, 2020. What matters is that it didn’t touch the top of wave (1), which would’ve been against the Elliott Wave rules.
The question is, if the same kind of pattern was followed by a 60% crash in 2008, can we expect a similar outcome now? According to the Elliott Wave principle, the predictive value of its patterns and the fractal nature of financial markets, the answer is Yes. If this count is correct, General Dynamics stock can lose another ~50%, before finding support below $140 a share. Not to mention that the general stock market has almost never been this overvalued and few would argue that housing is in a bubble again. The yield curve recently un-inverted after a period of prolonged inversion.
Is history repeating itself? Only time will tell, but it surely feels like it…
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