Elliott Wave Theory The Myth And Reality How To Start Trading The Forex Market Part 7 Believing These Six Myths Will Slash Your Currency Trading Profits
Elliot wave theory enjoys massive popularity – being described as advanced technical analysis, by many brokers and publishers.
Elliot wave theory has a huge and devoted following – shame the theory has no basis of sound logic that can help you make money!
Let’s look at Elliott wave theory in more detail and then look at sensible market analysis.
The theory was named after Ralph Nelson Elliott, who concluded in his book “natures law” that the movement of financial markets could be predicted by observing, and identifying a repetitive pattern of waves.
Elliott’s Profound Observation
Elliott came to the stunning conclusion that all natural phenomena are cyclical – and this includes the financial markets. This is true, but we know that anyway – we know that at some time in our lives, we will feel rain when we venture outside, the question is when exactly?
So, markets are cyclical – big deal! What we want from an investment theory, is the probability of the event – i.e. when is it most likely to occur.
Elliott wave theory is an objective investment theory – but there isn’t any objectivity in it at all!
It’s all a subjective interpretation of peaks and troughs, in any time frame you like!
Does this sound a logical predictive theory to you?
Based on rhythms found in nature, the theory suggests that the market moves up in a series of five waves and down in a series of three waves.
The difference between the Elliott wave principle and other cyclical theories is that the theory suggests no absolute time requirements for a cycle to complete – well that’s a lot of help!
The subjectivity is so great in Elliott wave, that like most theories, everything is explainable in hindsight – but the difficulty is actually predicting the future.
There are so many interpretations of the actual peaks and troughs in various time frames, that everyone will see them differently, this is hardly the basis of a predictive theory.
Elliott wave theory claims to be able to predict the market – but gives no objective way of doing it in practice.
Who uses Elliott Wave Theory?
1. Investors who want an easy way to make money, and are attracted to the mysticism of such tools as the Fibonacci number sequence, to predict market retracements.
2. Investors who believe in the false assumption that you can predict market behavior in advance – and want an easy way to make money.
How Markets Really Move
Market prices are a reflection of the following:
Supply and demand fundamentals + human psychology = price action
This looks simple, but is in reality, complicated equation – which is impossible to predict in advance.
Trading markets via technical analysis is all about putting the odds and probability in your favor, and no more than that. It is NOT a way of predicting the future.
Are there better theories than Elliott wave around, for making money from the markets? – A good exercise would be to poll the entire top performing fund managers in the world and see how many of them take the theory seriously.
Predictive and subjectivity don’t mix!
The Elliott wave theory is a predictive theory that leaves everything to subjective analysis.
If Elliott had worked out a predictive theory, why didn’t he give an objective way to make money from it? – Like most predictive theories it doesn’t work.
If all investors could predict the market in advance, we would all know what was going to happen – and there would actually be no market at all, as we would all know the market price in advance!
Elliott wave theory is supposed to be a predictive theory, but the only thing you can predict with it, is you will lose your money.
HOW DO Economic Events impact Global Currencies:
When I asked several traders about their thoughts about using fundamental analysis as a part of their trading decisions, I have received two opposite responses.
RESPONSE of Trader A
Fundamentals that you read about are typically useless as the market has already discounted the price. I am looking at (1) the long term trend, (2) the current chart pattern and (3) identifying a good entry point to buy or to sell.
RESPONSE of Trader B
I almost always trade on a market view. I don’t trade simply on technical information alone. I use technical analysis and it is terrific, but I can’t initiate or hold a position unless I understand why the market should move.
There is a great deal of hype attached to technical analysis by some technicians who claim that it predicts the future.
Technical analysis tracks the past; it does not predict the future. You have to use your own intelligence to draw conclusions about what the past activity of some traders say about the future activity of other traders.
For me, technical analysis is like a thermometer.
Fundamentalists who say they are not going to pay any attention to the charts are like a doctor who says he’s not going to take a patient’s temperature. If you want to be a successful trader in the market, you always want to know where the market is- up – down- trending or choppy .You want to know everything you can about the market to give you an edge.
Technical analysis reflects the vote of the entire marketplace and, therefore, does pick up unusual behavior. By definition, anything that creates a new chart pattern is something unusual.
It is very important to study the details of price action to see and observe. Studying the charts is absolutely crucial and alerts to existing disequilibrium and potential changes.
For forex traders, the fundamentals are everything that makes a country tick.
The release of economic & inflation indicators (i.e., consumer spending, employment cost index, government spending, producer price index, etc.), political actors, government policy or an individual event can set the market in a frenzy. These have to be considered when making the decision ” to trade or not to trade.”
Technical analysis, is a way of using historical price data in different ways to predict the future price of a currency pair.
Fundamental analysis is a very effective way to forecast economic conditions, but not necessarily exact market prices, and you SHOULD trade in agreement with the supporting technical indicators.
Foreign exchange traders put the most emphasis on technical analysis, because traders around the world use similar charts and tools in predicting market trends.
The reason the FOREX market can be so predictable some times is that if the majority are using the same graph for determining patterns and trends, then it is highly likely that they will act in a similar manner.
So several thousand traders who have all charted the same resistance line, for example, will most likely either set their trades and direction conform to that line.
When fundamental data is made available to the public there is a reaction from investors and speculators.
Information in the form of news and economic indicators is more vague than that of technical indicators. There is a lot of gray area in this type of analysis. The market will ultimately react to how people think the economic data compares to the current market situation.
Economic indicators usually reveal information that “Should cause a currency to go up in price” or “May cause a currency to go down”. The words “SHOULD” & “MAY” in the quotes above reveal the ambiguity of the fundamental data.
Here is an example of what analyzing fundamental data is like. Let’s suppose there are six economic indicators (there are a lot more).
Let’s call our six indicators 1, 2, 3, 4, 5, and 6. Now we wait for the data from our indicators to be published in a financial magazine or at an online source. We get the readings for our economic data for the EURO as following:
Indicator 1: is in a range where the Euro may go up
Indicator 2: is in a range where the Euro should go up
Indicator 3: is in a range where the Euro could go down
Indicator 4: is in a range where the Euro usually goes down
Indicator 5: is in a range where the Euro could go up
Indicator 6: is in a range where the Euro may go down
By looking at the above indicators, you don’t know what the Euro is going to do. Furthermore, currencies are always traded in pairs. So you would have to get the fundamental data for another currency pair and compare it with the EURO. I think you can image that this is not a simple task.
I do not want to discourage you away from fundamental data. The best way to learn is to learn about one piece of economic data at a time. Eventually you will build a puzzle from all of the fundamental and technical data and make more informed trading decisions.
Below you will find the six common beliefs followed by the bulk of traders – and if you believe these myths as well, then they will restrict your chances of making significant currency trading profits.
Ninety percent of currency traders believe at least one or more of these myths – which explains why ninety percent of traders don’t make much profit by trading currencies!
1. You should always be in the Market in Case you Miss a Move
Traders love excitement, and their view is, if they are in the market they may catch the big move. Well they may – but chances are they won’t.
The big trends only come a few times a year in each currency – and you should stay out the market until they come, otherwise you will take losses, and run up commissions that will deplete your account.
Wait for the big trades – patience is a virtue in trading.
2. Diversification Reduces Risk, and Increases Profit Potential
Diversification simply dilutes your profits.
You hit a big move, and your other trades that lose, or give you only marginal profits, eat up all your currency-trading profits.
You need to have confidence to go for the big moves, when they occur, and load up these trades.
Currency trading is about calculated risks – if the trade looks good, hit it hard for big profits.
3. Day Trading is Better than Long Term Trend Following, as it’s Less Risky.
Many brokers spread this myth – and why not? – They make more commission if you believe it!
You will end up having more losses than profits in your trading. You will never make enough money in a day to cover your inevitable losses. When you add in commission and slippage, it’s inevitable that you will lose.
You need to hold longer-term trends, as these yield the big profits to cover your smaller losses.
4. Timing the Market is the Correct Way to Make Profits
Timing the market means you are trying to PREDICT where prices are going to top and bottom – this is not a good way to trade and the odds are against you.
A better way to trade is to wait for the market to CONFIRM a trend is under way, and jump on board. You may not buy the bottom or sell the high, but you can catch the major chunk in between – and with currency trends lasting for many months or years, you can still get plenty of profits from the trend.
5. Markets are the Same Today as they Were Hundreds of Years Ago
Rubbish! Trends now are much more volatile than they were even 50 years ago. Why? Today, with the Internet, price information reaches every corner of the globe in a split second. This increases volatility as everyone has the same information at once – and everyone tries to enter the market at the same time.
This was not the case even 50 years ago – the trends are still there, but volatility is much higher – traders get the direction of the trend right, but they find themselves stopped out by the volatility. How often has this happened to you? – It happens to all traders. Look at using options to give you staying power.
6. You can use a Black Box System to Make Money
You can buy a system from a vendor for a few thousand dollars – and it can make 50 to 100% profit per annum.
These systems normally have a hypothetical track record – and use price information where the results are already known, and of course, the logic of the system remains hidden from you – as it’s unlikely to have a sound basis.
Have you ever wondered why these vendors sell systems, when they could simply get a bank loan and trade their own systems?
Enough said on this one!
How about some Positive Advice?
If you want to make big currency trading profits, you need to do it for yourself.
Get a plan you have confidence in, and execute the plan with discipline – and have the courage to trade for large gains when they occur..
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