Why This Correction May Be Shorter Than You Think
Plain Ewaver
"Bolton used to say that one of the hardest things he had to learn was to believe what he saw."
From "Elliott Wave Principle", Prechter and Frost, 1978.
To be honest, my original thought for the title of this essay was "Constraints on the applicability of Elliott Wave analysis in today's metals markets". But I realized that, given the mood of precious metals investors lately, the odds that a significant number of them would even open an article with such a title were lower than those of Iran outsourcing its uranium enrichment operations to Israel. So I chose a title that reflected the conclusion of this essay, not the process to arrive at it. Therefore, if you could not care less about Elliott Wave theory, let me tell you right away that I deem as the most probable outcome that this correction could be over by this week, and you are done. If on the other hand you are interested in this field, read on.
The underlying concept in the Elliott Wave Principle is that the stock market average - or any other price formed as the result of the interaction of a very large number of people in a free market - is the direct reflection of mass psychology (aka social mood), and as such its progress follows specific patterns. Quoting from an interview to Steve Hochberg, one of the top analysts in Robert Prechter-headed "Elliott Wave International":
"The Elliott Wave Principle is a direct reflection of mass social psychology, or as we call it, social mood. Social mood is not random nor is it cyclical, with any sense of fixed periodicity. However, it is patterned. It moves from abject pessimism to sheer ebullience and back in a three step forward, two step back fashion, the combined total of which is five legs. Each leg is called a "wave." The stock market is the most direct and immediate meter of social mood, so therefore one can readily access the patterns of social mood through studying the stock market. Since human beings do not change, the patterns that they go through also do not change. Moreover, these patterns occur in all time frames. Mathematically one would say that the Wave Principle is a fractal, with self-similar patterns at all degrees of scale. R.N. Elliott was the first to observe and catalogue these very specific patterns that recur as this progression unfolds from pessimism to optimism and back." (emphasis added)
Now, here is where I really start touching the issue referred to by the original title of this essay: Elliott performed his observations on the stock market during the 1930's and early 40's and published his two main books, "The Wave Principle" and "Nature's Law" in 1938 and 1946 respectively. Three decades later, Prechter and Frost took that body of knowledge, systematized and furthered it, and published the result in 1978 as the classic masterpiece "Elliott Wave Principle". The applicability of such a system derived from decades-old observations to today's environment relies on the obviously correct reasoning that, as Hochberg said, "since human beings do not change, the patterns that they go through also do not change." But what if a significant part of the participants in a market are no longer human beings?
Before you start questioning my sanity, please recall (or else read for the first time) this excellent article by knowledgeable commodity trader Dan Norcini: "The Big Dipper". It would be most timely, as it was written on February 10 in circumstances similar to today's (i.e. three days after a big drop in precious metals). Quoting from it:
"We seem to have entered an era in which extremes in both price action and volatility can be attributed directly to the plethora of computerized trading platforms and system traders which are increasingly coming to dominate the markets.
Try to imagine if you can thousands of computers running technical analysis software which are tied directly to online trading platforms. These electronic trading systems are designed for speed and objectivity. In other words, they are designed to eliminate any guesswork and/or human factors when it comes to the actual execution of trades.
The way these things work is pretty straightforward. A hedge fund for example will purchase a system, whether for intraday use or longer time frames, which is programmed with a set of parameters that it tracks in order to generate buy or sell signals. These signals are all based on price movement of some sort. Some of the systems will trigger a buy signal for instance, if the price exceeds the high of the last 5 days or a sell signal if the price drops below the low of the previous 5 days. Others are keyed to moving average crossover patterns. Still others are yet keyed to oscillator crossovers. The point is that such systems can easily and quickly be set up to automatically scan price action in any given market that is desired to trade in for such signals.
Now comes the interesting part. These trading systems have the capability of interfacing with the trader's electronic trading platform so that they can AUTOMATICALLY send the buy or sell signal directly to the exchange without the trader even having to manually enter the trade himself. The computer automates the entire process."
Evidently, this market environment is in stark contrast with the prevalent when Elliott made his observations (no computers at all) or when Prechter wrote his book (no computerized trading systems). Therefore, in those markets having a significant share of automated trading systems (if not in number, at least in the amount of money managed by them) we should expect some deviations from classic Elliott patterns. Some of those are the direct result of the operations of these systems as further described by Mr Norcini:
"With all these fully automated trading systems sending their orders to the exchange within seconds of one another, all price movements become incredibly exaggerated as sell order upon sell order is piled upon the next. The net result is that existing bids can be swamped in a matter of mere seconds producing a snowball effect that quickly becomes an avalanche.
This is precisely what we witnessed in gold on Tuesday, February 7, 2006, this week. It is also the exact same thing which we have seen for better than a year in the copper market as well.
The interesting thing about this is that while the intraday sell offs can quickly cascade out of control, the price reactions seem to be finishing up much swifter than they have done in the past with the result that the primary trend is reasserting itself much sooner than was the case formerly. In other words, though the price reactions tend to be more brutal on an intraday basis, they also are completed in a shorter time frame before the market resumes the direction of the previous trend."
In Elliott terms, what we get is zigzags that have fast and furious "A" waves but whose "C" waves are either dwarfs in comparison (as happened with gold and silver last December) or downright truncated (i.e. that do not go below the end of wave A) or both things at the same time. (Strictly speaking this deviations do not violate any Elliott rules, only guidelines.)
With all this in mind, let's see where we are in the wave count. As I said in my previous essay "Elliott Wave analysis for gold since 2001 - watch for 594", the attainment of that price level would render as the only valid wave counts those in wh