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Book Review of Review by Greg Nyquist
One of the most widely cherished assumptions of the modern age is that superstition, at least in advanced countries and among educated people, has finally been overcome and no longer plays a dominant role in society. But this view is itself a superstition, and serves as a kind of self-refutation. Only occult or religious superstitions have been overcome. Intellectual superstitions still reign supreme in the human mind, especially among the educated in the so-called "advanced" countries. As a case in point, consider the phenomenon of pattern analysis among investors. If you make a graph of the changes in price over time of any investment market, you will find that the changes form a pattern of cycles and epicycles. Some investors have struck on the idea that if the special secret of these patterns could be discovered, the future of price changes could be predicted. It goes without saying that anyone who could successfully predict future price changes of investment markets would likely become a very wealthy individual. Not surprisingly, few people ever become wealthy through the use of pattern analysis. But that doesn't stop people from trying to use graphs to forecast the future. One of the most sophisticated of the pattern analysts is Robert Prechter, author of At the Crest of the Tidal Wave. In recent years, Prechter has used pattern analysis to predict a great depression. In 1997, he wrote:
Although Prechter was wrong about the economy remaining expansive only for a few more months (the expansion would last three more years), he appears to be correct about the vulnerability to a "dramatic contraction." Does this mean that Prechter's methods of "wave analysis" are sound? Or is Prechter merely correct for reasons having nothing to do with pattern analysis and his so-called "Eliott wave principle"? Prechter himself admits that he has made mistakes that has cost him money. "I concluded after the [1987] crash that the bull market was probably over and did not re-enter the market." Since he has been predicting another crash since 1995, he has probably missed out on the biggest bull market in history. But that is one of the hazards of pattern and wave analysis. Even at its best, wave principles can only give a vague indication of where the market is going during an indefinite period of time. If the market has gone up for a long time, you can predict, with a great deal of accuracy, that sooner or later (and probably sooner than later) the market will drop. You might even be able to come up with a fairly good idea of how far the market will fall. But you can never determine precisely when the market will take its fateful plunge. The other problem with Prechter's thinking is his analysis of the causal forces behind his wave principles. It has long been known that social processes ebb and flow, rise and fall, grow and contract. But such oscillations do not, in and of themselves, prove the existence of any so-called wave principles, because the oscillations themselves may be sui generis phenomenon, mere coincidences in the Heraclitian flux of will and matter. Before the social theorist can definitely affirm the existence of wavelike phenomenon in economics and society, he has to show that these oscillations must occur, that they are effects of deeper causal processes evolving out of the very nature of the social order. This being the case, what sort of causal explanations does Prechter give for his Elliot Waves? Prechter relies almost entirely on psychological explanations. "It is the psychology behind the markets that creates the bottoms and tops," he writes. "The engine of markets is psychological change." The "Stock Market is driven by social psychological forces as opposed to individuals' rational assessment of corporate value." While all these statements have an element of truth (and some of them a large element), none of them are entirely adequate as explanations of economic and market behavior. No one doubts that psychology is a major player in the overall farce. But psychological explanations can never explain everything that happens in markets. Investment behavior, Prechter asserts, is "marked by psychological extremes, as investors move from depression to euphoria." Very well. But what, precisely, causes these extremes? Prechter explains the phenomenon in the following terms:
Although this may all be true, it misses the point at issue.
Differences in emotional states are reactions (or, rather, overreactions) to movements in the market. But what, precisely, is moving the market? That is the main question, and it is this question
that receives short shrift in Prechter's analysis. When he deals with the question at all, he tends to fall back on his own analysis, reifying his market waves into powers and causes, as if the oscillations in the prices of investment properties were the consequences of Mr. Prechter's ability to chart them on a graph. At one point, we find him declaring that "the classic error of all conventional
analysis ... is to assume that events cause cycles rather than understanding that cycles prompt events." But this is clearly wrong. Cycles are products of analysis, of thought: they are, at best, mere
descriptions of events. To consider a mental description of an event as the cause of that event is about as flagrant an act of intellectual superstition as the mind is capable of committing. Cycles don't cause (or "prompt") events;
cycles are events. Prechter's confused analysis vitiates the many psychological insights he provides concerning market behavior. |