EW Useless for Traders

Saturday, January 09, 2010

Expanding on an idea from Tim Knight over at Slope of Hope:

"A theory that does not present a set of conditions under which it would be considered wrong would be termed charlatanism - it would be impossible to reject otherwise. Why? Because the astrologist can always find a reason to fit the past event, by saying that Mars was probably in line but not too much so (likewise to me a trader who does not have a point that would make him change his mind is not a trader)." (Fooled by Randomness - Nassim Nicholas Taleb)

Is this not Elliott Wave in a nutshell? I continually hear traders talk about patterns based on EW and I fight the urge to tell them what a fool they are. Initially, I approached EW with an open mind and tried to understand the theory. Yet, I was very rarely able to make any money trading the supposed patterns. A more in-depth study of the theory revealed to me a fatal flaw and I no longer see any value in EW as a trading strategy.

I'd be happy to be proved incorrect on this but my view is that EW suffers from the definitional fallacy and is, therefore useless for anyone looking to make decisions based on its "predictions". Simply put, under the theory it cannot be false. If a trader outlines a pattern that he believes in EW, and it doesn't work in the way EW would dictate, then it is not EW. So an EW pattern is only an EW pattern if it turns out to be an EW pattern. This is circular logic and fallacious.

Let's look at another example to compare. A bull flag is a classic bullish technical pattern that consists of a trend move higher, then a sideways consolidation. Traders use this pattern to predict a move higher upon a break of the upside of the so-called flag. Yet, following the logic of EW: if the stock moves higher, then it was a bull flag; if it fails to go higher, then it actually wasn't a bull flag. Nonsense!

If EW is only EW after the fact, then it holds absolutely no predictive power. EW can only be correctly identified upon completion of the pattern. EW is charlatanism. (Guess today was my Prechter-bashing day!)


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