A 300-point drop in the Dow during the week of Sept. 28 looks and feels different from the recent bear market rally that many people (but not us) have called a new bull market. As stock markets reach a peak, though, they start to lose momentum – something like the calm before a storm. Just as meteorologists can use instruments to measure the changing strength of an approaching hurricane, Elliotticians use wave analysis to measure waxing and waning markets. In this excerpt from Bob Prechter's question-and-answer book, Prechter's Perspective, he talks about what a topping market feels like.
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Would you describe what it feels like when a bull market in stocks tops?
Bob Prechter: Unlike commodities, stocks don't just blow off. If you throw a ball into the air, it has to slow down before it comes down. The market doesn't exactly follow the laws of physics, but its action does seem to reflect this one. Even the 1929 high was accompanied by "top building," that is, a glaring divergence in the six-month percentage rate of change. In the stock market, the idea is a psychological feeling more than a true description of a stock market chart formation. The market slowed into the 2000 top, too. The advance/decline line topped in April 1998, and the corrections of 1997 and 1998 set up momentum divergences in the first quarter of 2000.
Does this slow topping process serve any function?
Bob Prechter: Many manias in history have outlasted the Cassandras and, in the process, have devastated the finances of the largest possible number of people. The crowd is buying fantasies. When fantasies get far out of line with reality, you've been presented with the opportunity to make money, whether it's on the downside or the upside.
But a contrary stance can't be rewarding unless one is following the Wave Principle?
Bob Prechter: Precisely. The problem is that contrarianism is only a one-way comment. The observation made by contrarians is that at the top of a market, there will be a substantially greater number of bulls than bears. This is a fact, but it doesn't tell you how far the pendulum can swing in one or the other direction. That is why the Wave Principle is necessary. It provides a background for knowing when to go with a trend and when to go against it.