A famous quote attributed to Archimedes, the ancient Greek mathematician, is: "Give me a place to stand and with a lever I will move the whole world." And, as you probably know, leverage can also move the stock market.
In the July-August Elliott Wave Theorist, Robert
Prechter discussed the role of leverage in sending the market
to new price highs.
First, take a look at this chart from that issue, and then read Prechter's commentary.
Margin debt, incredibly, is up 100 times in the
last 39 years (see the chart above). It was $4 billion back
in 1974; it's nearly $400 billion today. That is a big reason
why stock prices are in the stratosphere. You might think
that there's a lot more money around, thereby justifying
the rise. ... Let's normalize this indicator to GDP and
see what we have. ... [M]argin debt as a percentage of annual
GDP is still 10 times the 1974 level. ... The current
ratio is also 3 times what it was at previous major
tops in the stock market in the 20th century.
-- The Elliott Wave Theorist, July-August 2013
Margin debt levels are not a precise market timing indicator, but one major financial firm advises caution.
"Investors have rarely been more levered than today," said Deutsche Bank, warning that the spike in margin debt is a "red flag" and should be watched closely. ... It said the equity rally may have further legs but it cited "astonishing similarities" between the latest patterns and events preceding prior market crises.
-- The Telegraph, August 13
The high levels of margin debt in the stock market should be a concern to every investor, as should other indicators that Elliott Wave International reviews.
You can learn what EWI sees ahead for the market by reviewing
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article was syndicated by Elliott Wave International and
was originally published under the headline A Big Reason Why 2013 Stock Prices are in the Stratosphere.
EWI is the world's largest market forecasting firm. Its staff
of full-time analysts led by Chartered Market Technician
Robert Prechter provides 24-hour-a-day market analysis to
institutional and private investors around the world.
You can find low-risk, high-confidence trading opportunities by trading with the trend. The trick is to find the end of market corrections, so you can position yourself for the next move in the direction of the trend.
This excerpt from Jeffrey Kennedy's free 47-page eBook How to Spot Trading Opportunities explains where to find bullish and bearish trade setups in your charts and how to zero-in on these opportunities. If this lesson interests you, the full 47-page eBook is free through July 16.
On the left-hand side of the illustration below, there are two bullish trade setups. As traders, we want to wait for the wave (2) correction to be complete so we can catch the move up in wave (3) -- this is the trade. What we are trying to do in this bullish trade setup is anticipate the potential for profits on the buy-side as prices move up in wave (3). Another bullish trade setup is at the end of wave (4).
As traders, we are looking to buy the pullback and position ourselves within the direction of the larger up-trend. Remember, three-wave moves are corrections, which means that they are countertrend structures. On the other hand, five-wave moves define the larger trend. As traders, we want to determine what the trend is and trade in the direction of the trend. Our buying opportunity to rejoin the trend is whenever the trend pauses and forms a correction.
Now, let's look at the right-hand side of the illustration where we see two bearish setups. When a five-wave move is complete, it is retraced in three waves as a correction. The end of the five-wave move presents the first trading opportunity that we can take advantage of the short side (or the sell side) as the wave (A) down begins.
Notice the second bearish trade setup gives us another shorting opportunity as wave (B) tops.
So, within the classic wave pattern of five waves up and three waves down, we have four high-probability trading opportunities in which we are either positioning ourselves in the direction of the trend or identifying termination points of a trend. I want to share with you some tricks I have picked up over the years about how to analyze corrective waves and their termination points. The single most important thing I've learned from analyzing corrections is that corrective or countertrend price action is usually contained by parallel lines.
As shown above, draw the parallel lines by beginning at the origin of wave A and going to the extreme of wave B. You draw a parallel of that line off the extreme of wave A. So basically you have a small, slightly angled downward price channel. This will show you the containment region for wave C. It also shows you an area toward the bottom of the lower trend line where you can expect a reversal in price.
Here is another example. Again, you draw the parallel lines off the origin of wave A, the extreme of wave A and the extreme of wave B.
Toward the upper end of the upper trend line, you will usually see a reversal in price.
This example shows how countertrend price action is contained by parallel lines in the British pound, 60-minute, all sessions. Why is it important to know parallel lines contain the corrective or countertrend price action? Number one, it will increase your confidence that you are indeed labeling a countertrend move properly. Number two, it identifies areas where you will likely see prices reverse. For example, we see this reversal up near the top.
What to Learn More? Get the FREE 47-Page eBook
This brief trading lesson is just a small example of the opportunities you can find once you learn to identify key market patterns. Learn more in your free 47-page eBook, How to Spot Trading Opportunities. This valuable eBook is regularly $79, but you can get it free through July 16.
As the biggest credit bubble in history continues to shrink, consumer prices have stayed flat over the past several months, meaning there is ZERO sign of inflation in the economy -- despite growing commitments from the U.S. government.
So what's keeping inflation at bay, given all the stimulus money promised? The answer: Deflation -- an overwhelming urge for consumers to liquidate their assets for cash.
And this new economic phase is finally becoming too obvious to ignore, as explained in recent commentary from the world's largest technical analysis firm. "The economy is moving into a critical new phase, an outright deflation in which 'prices fall because people expect falling prices.' Obviously, this implies an element of recognition, as efforts to protect against indebtedness and falling prices contribute to further declines. We can tell deflation is entering a new stage because of the language and ideas that financial observers now use to describe it." -- The Elliott Wave Financial Forecast (September 2010)
So how do you protect yourself from deflation? The first step is to understand it.
Elliott Wave International has put together a complimentary 90-page ebook, now updated with 30 new pages of commentary from Robert Prechter through 2010. The ebook is designed to help you prepare, adapt, survive and prosper in the event of deflation.
Prechter has spent most of the past decade as an outcast among financial forecasters, because of his certainty that deflation would soon shock virtually all investors – despite the policy makers and string-pullers who promised to prevent it.
To show you just what Prechter's deflation forecast was up against, consider this: Experts from all schools of the economics profession said deflation was "utter nonsense," a preoccupation of "small children," and as likely to happen as "being eaten by piranhas." How could deflation begin when the entire economics profession unanimously said it's not possible?
Yet there's no question some deflation HAS occurred. The question now is, will it get worse?
In his new 90-page ebook, you'll see why Prechter argued deflation was likely, and why he was certain a monumental deflationary trend would unfold sooner rather than later.
Remember, deflation is extremely rare; it last happened in America almost 80 years ago. So, a forecast of deflation that proves accurate is a monumental feat – especially when all the "experts" disagree.
So if economists were unable -- or worse, unwilling -- to warn you in advance about the threat of deflation a few years ago, what are they not warning you about now?
It's time you gave the deflationary scenario a serious look.
In the 1930s, Ralph Nelson Elliott, a corporate accountant by profession, studied price movements in the financial markets and observed that certain patterns repeat themselves. He offered proof of his discovery by making astonishingly accurate stock market forecasts. What appears random and unrelated, Elliott said, will actually trace out a recognizable pattern once you learn what to look for. Elliott called his discovery "The Elliott Wave Principle," and its implications were huge. He had identified the common link that drives the trends in human affairs, from financial markets to fashion, from politics to popular culture.
Robert Prechter, Jr., president of Elliott Wave International, resurrected the Wave Principle from near obscurity in 1976 when he discovered the complete body of R.N. Elliott's work in the New York Library. Robert Prechter, Jr. and A.J. Frost published Elliott Wave Principle in 1978. The book received enthusiastic reviews and became a Wall Street bestseller. In Elliott Wave Principle, Prechter and Frost's forecast called for a roaring bull market in the 1980s, to be followed by a record bear market. Needless to say, knowledge of the Wave Principle among private and professional investors grew dramatically in the 1980s.
When investors and traders first discover the Elliott Wave Principle, there are several reactions:
Disbelief – that markets are patterned and largely predictable by technical analysis alone
Joyous “irrational exuberance” – at having found a “crystal ball” to foretell the future
And finally the correct, and useful response – “Wow, here is a valuable new tool I should learn to use.”
Just like any system or structure found in nature, the closer you look at wave patterns, the more structured complexity you see. It is structured, because nature’s patterns build on themselves, creating similar forms at progressively larger sizes. You can see these fractal patterns in botany, geography, physiology, and the things humans create, like roads, residential subdivisions… and – as recent discoveries have confirmed – in market prices.
Natural systems, including Elliott wave patterns in market charts, “grow” through time, and their forms are defined by interruptions to that growth.
Here's what is meant by that. When your hands formed in the womb, they first looked like round paddles growing equally in all directions. Then, in the places between your fingers, cells ceased growing or died, and growth was directed to the five digits. This structured progress and regress is essential to all forms of growth. That this “punctuated growth” appears in market data is only natural – as Robert Prechter, Jr., the world's foremost Elliott wave expert and president of Elliott Wave International, says, “Everything that thrives must have setbacks.”
The first step in Elliott wave analysis is identifying patterns in market prices. At their core, wave patterns are simple; there are only two of them: “impulse waves,” and “corrective waves.”
Impulse waves are composed of five sub-waves and move in the same direction as the trend of the next larger size (labeled as 1, 2, 3, 4, 5). Impulse waves are called so because they powerfully impel the market.
A corrective wave follows, composed of three sub-waves, and it moves against the trend of the next larger size (labeled as a, b, c). Corrective waves accomplish only a partial retracement, or "correction," of the progress achieved by any preceding impulse wave.
As the figure to the right shows, one complete Elliott wave consists of eight waves and two phases: five-wave impulse phase, whose sub-waves are denoted by numbers, and the three-wave corrective phase, whose sub-waves are denoted by letters.
What R.N. Elliott set out to describe using the Elliott Wave Principle was how the market actually behaves. There are a number of specific variations on the underlying theme, which Elliott meticulously described and illustrated. He also noted the important fact that each pattern has identifiable requirements as well as tendencies. From these observations, he was able to formulate numerous rules and guidelines for proper wave identification. A thorough knowledge of such details is necessary to understand what the markets can do, and at least as important, what it does not do.
You have only just begun to learn the power and complexity of the Elliott Wave Principle. So, don't let your Elliott wave education end here. Join Elliott Wave International's free Club EWI and access the Basic Tutorial: 10 lessons on The Elliott Wave Principle and learn how to use this valuable tool in your own trading and investing.
Gold, the Dow, T-Notes: Which Does Best During Recessions?
Each year, the NCAA college basketball tournament winnows its starting field of 64 teams to the Final Four teams who play for a chance to become the national champion. Congratulations to the University of Kansas and the University of Tennessee, this year's men's and women's basketball champions.
The structure of the NCAA tournament got me to thinking. Wouldn't it be great if we could set up brackets for our own investments the same way – start with 64 equities, bonds, mutual funds, commodity futures, metals, etc. Then let them duke it out against one another to see which ones emerge as the "Investment Final Four"?
Click here to download a free 5-page report from Elliott Wave International with even more information on which investment does best during recessions. The report, excerpted from Bob Prechter's Elliott Wave Theorist, includes in-depth historical analysis and six eye-opening tables.
Since most of us have neither the time nor the money to act as our own version of the NCAA (which might stand for the "National Coordinator of Asset Allocation"), it's worth knowing that Bob Prechter of Elliott Wave International has already set his mind to the task. He has specifically explored which investments do best in times of recession and which do best during economic expansions. But instead of starting with a field of 64 investments, he researched the three most popular investments – gold, the Dow, and Treasury bonds. We can call them the Treasured Three, rather than the Final Four.
Gold and Recessions
Since economists and even Ben Bernanke, chairman of the Federal Reserve, now admit that it looks like the U.S. economy has entered a recession, many people may wonder whether they need to change the mix of their investments. In particular, as some prices keep going up – notably for food and gas – the threat of inflation makes people more interested in gold as an investment, since it's usually seen as a bulwark against monetary inflation.
It is this conventional wisdom that piqued Prechter's curiosity. He wanted to find out whether it would hold up to a reality test. As he writes in The Elliott Wave Theorist, "I have often read, 'Gold always goes up in recessions and depressions.' Is it true? Should you own gold because you think the economy is tanking? Whenever we hear some claim like this, we always do the same thing: We look at the data."
So he and another Elliott wave analyst ran the numbers, reviewing the behavior of these three key investments during recessions following World War II, from February 1945 through November 2001. This is what they learned:
Gold was not the best investment during recessions in terms of total return.
The winner of this tournament was actually Treasury Notes, which had a total return of 9.96%. In contrast, gold had a total return of 8.80%, and the Dow came in at 6.89%. But that's not all – once they figured in the transaction costs for each investment (at a 2008 level), gold fell from second to third place as a worthwhile investment during recessions. The total returns with transaction costs came out this way:
This result turns conventional wisdom on its head. It's also worth being aware of as you invest in 2008. Here's how Prechter sums up the results:
The Best Investment During Recessions
The most important question, however, is not whether the Dow beat gold or vice versa but whether making either investment would have been better than taking no risk at all. Table 3 [see free report provided by Elliott Wave International] shows that ten-year Treasury notes beat both gold and the Dow during recessions since 1945, and they did so far more reliably. T-notes provided a capital gain in 10 of the 11 recessions, and of course they provided interest income during all of them. And the transaction costs are low….
So if you want to make money reliably and safely during recessions and depression, you should own bonds whose issuers will remain fully reliable debtors throughout the contraction. Of course, as Conquer the Crash [Editor's note: Bob Prechter's best-selling business book] makes abundantly clear, finding such bonds in this depression, which will be the deepest in 300 years, will not be easy. Conquer the Crash forecast that in this depression most bonds will go down and many will go to zero. This process has already begun. This time around, you have to follow the suggestions in that book to make your debt investment work. [The Elliott Wave Theorist, March 2008]
Susan C. Walker writes for Elliott Wave International, a market forecasting and technical analysis company. She has been an associate editor with Inc. magazine, a newspaper writer and editor, an investor relations executive and a speechwriter for the Federal Reserve Bank of Atlanta. Her columns also appear regularly on FoxNews.com.