Generally speaking, the broader an index is in terms of number of companies whose stocks are listed, market capitalization and active market participants, the more suited it is for Elliott Wave Theory analysis.
A basic premise of the Elliott Wave Theory (or Elliott Wave Principle, as it is also known as) is that the financial markets manifest recurring price patterns, sometimes described as fractal price patterns. From this description, novices are often drawn to making the conclusion that by using the Elliott Wave Theory one can successfully predict the market, which in actual practice is not particularly easy, and which the theory itself actually disproves (prediction and predictability are not the same) if one studies the Elliott Wave Theory for long enough to understand it properly. That however, is a topic for another blog post.
We started out on the Swedish market more than 10 years ago, and back then we used the NASDAQ OMX index called OMXS30, as well as the Dow Jones Industrial Average (DJIA) (or Dow 30, as it is sometimes referred to, for our Elliott Wave analysis.
While these two indices did offer Elliott Wave patterns, over time we found that the OMXSPI and S&P500 indices, for the Swedish and US markets respectively, produced more accurate wave patterns. And so we switched completely to using only these two broader market indices.
Generally speaking, an index with more stocks in it, will produce a clearer wave pattern. However, it also depends on the composition of the index. If you look at, for instance, an index with only a particular industry sector of companies in it, then that index – even if there are 100 or 1000 stocks in it – might not produce proper wave patterns at all times, even though it may still do so during certain market phases.
In general, we recommend that Elliott Wave Theory analysis be carried out on a broad financial market index, where the word “broad” is to be judged with respect to the following aspects:
- Amount of stocks in the index. Higher is better.
- Number of industries and sectors represented in the index. Higher is better.
- Market capitalization. Higher is better.
- Active trading participants. Higher is better.
With that said, the narrower leading indices of many nations, such as for instance CAC40 in France or DAX 30 in Germany, do suffice for monthly, weekly and daily wave analysis. Although not ideal, France and Germany are big nations, with big economies, and lots of capital flowing through their financial markets.
The same type of index with only 30-40 stocks in a smaller nation whose capital markets are less capitalized, might however be less-than-ideal for Elliott Wave analysis. Lesser market capitalization, fewer industries, and lesser market participants over all, does make a significant difference.
Last but not least, if you are already satisfied with Elliott Wave analysis (and its practical outcomes) you produce on a narrow index, don’t be too quick to change to a broader index just because someone told you to do so. Altering a winning concept is not wise. If you are happy with your analysis and trading results while working with narrow indices, that’s great.
Market analysis and trading is not strictly a science, and the personality and preferences of any participant must be factored in. If you are new to Elliott Wave analysis and want to get started, then however it is recommended that you find a sufficiently broad (with respect to the 4 points above) financial market index to get started. Good luck! 🙂