The role of Elliott Waves in oil prices

In August 2005, over on DU's Peak Oil board, Nederland, robertpaulson and I made a bet on the price of oil. The bet was whether three years later on August 31, 2008, oil would be above or below $70 per barrel. The bet was for the price of one barrel of oil on that date.

At the time I was a Peak Oil fundamentalist, and thought I had the future of oil pretty well figured out -- rising prices forever, even in the face of the inevitable economic slowdown triggered by stagnant or declining oil supplies. As it turned out, robertpaulson and I won the bet, as oil closed at $115 that day. But the price was already on its way down from the June high of $147, and six weeks later it slipped back below $70 on its way down to $40 -- from which it has recovered back to, yep, around $70.

The outcome of that bet taught me that there's a lot more to oil prices than simple supply and demand. There's speculation of course, and there are the underlying economic drivers (the price of a resource drops when people stop doing things that require it). But above all there seems to be a lot of "Elliott Wave" socionomic influence. I'm just learning about Elliott waves, but at the most basic level, Elliot Waves seem to reduce to "human herding behaviour". When people see the price of something go up they assume it's becoming more valuable, rush to buy it, and -- lo and behold -- the price keeps going up. Then the social mood changes, the price begins to fall, and people flee the investment -- causing the price to fall even further, until the social mood changes once again and the price starts to rise once more.

My basic error was in assuming that the oil market (like any other market you care to name) is rational, and tends towards equilibrium, a model also known as the Efficient Market Hypothesis. In fact, it seems as though prices largely ride on (or reflect) the prevailing social mood, whether they are prices for oil or stocks. Because they reflect human psychology at least as much as their underlying fundamentals, there is no reason to expect stock or commodity prices to reach an equilibrium, or to purely reflect the fundamentals.

This understanding appears to be what enables some speculators to make a killing an any market. Either consciously or unconsciously they read the "social mood" of the market, get ahead of the price movement and make a killing. Those of us who think the market is an aggregation of rational actors and is driven largely by its fundamentals (even if those fundamentals are somewhat skewed by profiteers) are destined to lose our shirts, because our responses will always lag the prices.

I still think that Peak Oil is a real, geological phenomenon, but I now have a somewhat more nuanced view of how that will play out in the real world, especially with regards to oil prices. One of the factors I had seriously underestimated is the power of social mood and human herding. My recent introduction to the Elliott Wave principle has shed a lot of light on that aspect of markets, and also on the possibility for rapid, large-scale changes in social mood that would be needed to drive a move towards conservation and other kinds of ecologically friendly behaviour.

But don't Elliot waves take place within the larger frame of supply and demand? I alaways thought of Elliot waves as something that sits ontop the fundemantal basics of the economy (taking the textbook factors) rather than operating on the same fundamental level.

In the case of oil my idea would be something like this: As long as there is the possibility of a productive equilibrium (as there still is with oil) speculative Elliot waves can demolish or skyrocket prices. But as soon the productive equilibrium gives way - imagine us finding out that we can tap oil from another dimension in unlimited quantities / the production of oil ultimatly falling steady despite huge efforts in new exploration (peak oil) - Elliot waves become insignificant in regard to the fundamentals. In the first case that would mean no Elliot wave could be as powerfull as to push the price of oil high when there is unlimited supply, in the second case that would mean no Elliot wave could be powerfull enough to lower prices facing a supply steadily growing to zero.

In a post-peak situation, where we are still trying to grow our economies, we could get into a spike-and-crash scenario with oil. Both the spikes and crashes will driven by social herding to some extent. First, the attempt to restart the world's economies generates a optimistic social mood, so everybody tries to restart their own economic engine and the oil price spikes. At some point the price gets high enough that people begin to fall out of the effort and the sense discouragement spreads, creating a negative mood which in turn drives the prices down hard.

I think what you may see is an Elliott Wave structure developing in the price chart of oil, that mirrors the underlying social mood. Some people may make money using it as a market timing tool, because I think that the structure will be recognizable, but that the herding will amplify the price swings. It may even become easier to use EW as a timing tool in that case since the pattern will become more visible because of the amplification.

I'm just speculating here, because I don't know enough about EW theory yet to do more than that.

"Elliot Waves" are an emergent pattern that can help us recognize the underlying social mood that is driving the measured indicator. They seem to be a signal of the underlying psychology of the herd, which is what can be viewed as the fundamental factor. It would surprise me if EW ever became a fine-grained predictive tool, though some market analysts are giving it the old college try. For me, the most important thing I've gotten out of studying EW so far is a better appreciation of human herding behaviour.

and would not attempt to label counts for anyone but myself.


http://www.democraticunderground.com/discuss/duboard.php?az=view_all&address=327x792

March 2009...

"...Bear in mind the market is not rallying because of this nonsense. The market is rallying because at a minimum, it was technically very oversold and was ready to rally. Furthermore, this rally has the potential to be much stronger than most think.

...People have been asking for an update of the E-Wave count I have been following. The last update I offered was on January 9, 2009 in S&P 500 Crash Count - Wave Four Triangle.

On October 28, 2008 in S&P 500 Crash Count - Wave 3 Update I posted this interpretation of what might happen.


...The above idea worked pretty well. Moreover, it now appears as if the S&P 500 has traced out 5 clean waves down, ending at 666. If that is the case and wave 5 does not extend, it will not be fun to be net short at this point whether or not lower lows are ultimately coming later or not..."


Also...

About the McClellan Oscillator and Summation Index

http://www.democraticunderground.com/discuss/duboard.php?az=show_mesg&forum=327&topic_id=716&mesg_id=716

it is one of the most ridiculous theories ever created in the ivory tower (where theory trumps results).

as a person who makes income trading, i have always known it's bullshit.

fwiw, i work with a few traders who use elliot wave to help their modeling.

personally, i think it has little to no predictive value, but does help to contextualize market action.

iow, i'm not a fan. but i know some very successful traders who incorporate it.

i use mostly market profile and order flow myself.

(look at the US stock market, I wouldn't invest a penny in GM stock or bonds)

at any one time, there is 50 trillion USD floating around,
looking for a place to be invested, which is comparable
to the financial output of the global economy, for a year.

........................................
there are mutual funds, with assets of hundeds of billions, example GSCI,
that do nothing but buy commodity contracts that are 'three months away,
and sell when one month away.
.......................................................

look at the crash
147 oil
55000 a ton nickel, now 14000
6000 an ounce rhodium, now 1500.
8 dollar corn, now 4
platinum
palladium
lead, zinc,
wheat, soybeans
copper, tin
natural gas, refined gasoline etc, etc

has been around since the 30's. It's based mainly on charting, and it's sort of like the I-Ching for stock pickers. One of its leading practitioners is a guy named Robert Prechter, who used to be a regular guest on Wall Street Week, back in the day. As far as I know, Prechter has never been right about anything market related. Interestingly, despite being consistently wrong, Prechter seems to find steady employment as a financial guru. Psuedo-science is very seductive. Start throwing Fibonacci numbers around and apparently investors' eyes glaze over and they hand you their money.

What moves oil prices and where we go from here has been explored at length over at the Oil Drum. Nobody has come up with a Universal Theory yet; at least none that has inspired consensus. The general thinking seems to be that there are more variables governing oil price movements than we thought (duh). The notion that peak oil would mean higher prices was seductively simple. It made a great story. You bought it. I bought it. So did lots of other people. Then it quit working. I think the reason prices have gone back up is that a lot of people are still using that story as a basis for action. Inflation worries are also a factor, especially since oil is priced in dollars.

I think it depends on what kind of recovery follows this recession. The big thing that everybody ignored was the dampening effect high oil prices would have on the economy, and the reciprocal effect of a collapsing economy on oil prices. It's too easy to blame oil price fluctuations on a band of crafty speculators who have some special insight into popular delusions and the madness of crowds. There's just a lot of stuff happening that's out of sight as far as we're concerned. For example, the Chinese are buying oil for their strategic reserve, and are also cutting deals right and left with oil producing states. I don't think anyone knows the extentof that activity. The Saudis are notoriously secretive and who knows what the Russians are up to. It's all very complicated.