http://www.investopedia.com/universi...liottwave4.asp
Summary of the below tedious reading: Elliott wave is statistically proven to work, only on liquid securities and markets. which is 35% of stocks. and some other markets, forex!!!
Putting Elliott to the Test
In 1994, a small team from Perth led by Rich Swannell began designing Elliott Wave computer programs for traders. Swannell was a programmer first and trader second. Very few in the world of trading are good at both.
During the early years, the team consulted with Elliott veterans, conducted intense research, and developed what Swannell claims was the world's first comprehensive software program designed to analyze price data using the rules and guidelines of Elliott's theory. The problem with the software was that it was based on observations and not an exhaustive statistical analysis of wave reliability. And, while results from the software were respectable, without probabilities the trader was still trading blind. How could a way be found to overcome this weakness?
The team came up with a novel solution. Swannell developed a screen saver in 2001 that would work in the background on the computers of more than three thousand volunteers. While not being used by their owners, these machines would be scanning a universe of stocks, commodities and indexes to search for and analyze Elliott Wave patterns. The goal was to determine once and for all which patterns worked, which did not and even whether the Elliott Wave theory itself had sufficient merit to trade it with confidence. It was all based on mathematical probabilities.
After eighteen months and hundreds of thousands of hours of computer time, the team had enough data to start analyzing it. For those interested in more details, Swannell wrote a book about the experience, "Elite Trader's Secrets: Market Forecasting With The New Elliot Wave System" (2003); it includes a good analysis of Elliott patterns. Here is a summary of what they found:
- Not only did the Elliott Wave theory prove to be statistically sound, the research was able to generate the probabilities of a forecast being correct. In other words, the trader could now know the chances of a wave pattern and the resulting forecast with a low margin of error (statistical significance).
- The most common Elliott Wave patterns were often significantly different in both shape and frequency than the previous conceptions of them. Some patterns that were previously believed to be reliable did not work often enough to be used with any degree of confidence.
- The team confirmed Murray Ruggiero's finding that a correct wave count is not the most important factor in trading. Even with the help of a good program, all Elliott forecasts are, at best, an educated guess: a trader can never be certain because there is always a larger pattern that cannot be included in the analysis unless he or she goes back to the beginning of time. Swannell's team found that since many alternate counts result in similar forecasts, this problem of possible inaccuracy is not as critical as many previously thought. As long as a count is arrived at logically, adheres to the rules and is confirmed over various time periods, it doesn't matter what the larger degree (next largest wave pattern) is. In Swannell's findings, the most probable scenarios gave exactly or at least very similar forecasted results. This finding is crucial to a trader's success and means that, as Ruggiero says, the count is of less importance than the penalty for being wrong, which is the loss on the trade.
- By performing forecasts in various time frames, the team separated the issues that worked from those that didn't. Forecasts for those that exhibited no consensus over various time periods were deemed unreliable (see our example below for a more detailed explanation). The probability for failure in most cases was greater than the probability for success, so why take the chance?
Of the thousands of equities, indexes and commodities tested, Swannell's team found that in about 65% of the cases, Elliott Wave theory proved too unreliable to be used to trade with any degree of confidence. In other words, using the theory to trade the instruments included in this 65% would prove a losing proposition. It means that traders should limit their focus to the 35% that proved to be viable trading candidates.
But why did only about one-third of the candidates work using Elliott? It has to do with the basis of the Elliott principle, which quantifies market crowd behavior. Elliott Wave theory works best in equities that (1) have lots of volume (liquidity) and (2) move according to key forces of fear and greed on the part of many participants. When a security is not prone to this crowd behavior and is controlled instead by a few strong hands, Elliott patterns begin to break down. Issues traded by a few are more subject to manipulation and control and, therefore, are more difficult to forecast.
Elliott warned us that his theory worked best on indexes and very liquid securities, so Swannell's finding was not all that surprising. But now the notion was proven and quantified and a list of trading candidates was identified. In the process, a large amount of subjectivity and uncertainty was removed. All this information was now stored and available in a large database for immediate computer reference.
