Founder and president of Elliott Wave International

Chosen “Guru of the Decade” (1980s) by Financial News Network (now CNBC)

Author or editor of 13 books, including New York Times best seller Conquer the Crash

For the rest of Robert Prechter’s life, he will always be linked to something he did in 1987:

Prechter . . . known for his prediction of the 1987 stock market crash . . . (Wall Streetlournal)

Prechter . . . [who] forecast the 1987 market crash . . . (New York Times)

Prechter ... who told investors to sell their stocks weeks before the October 1987 crash . . . (Barron’s)

When you’re a stock market analyst, it doesn’t get much bigger than predicting a crash—and getting it right. But Prechter wants to be appreciated for more than that.

“People tend to say, ‘Oh, he just calls crashes,’” Prechter says, “but I was super-bullish through the whole 1980s, actually from 1975 forward.”

He wants to be known for his overall predictions.

“If they’re going to go back that far,” he says, “I wish they’d say I wrote a super-bullish book in 1978 (Elliott Wave Principle—Key to Market Behavior), updated it in 1982, and called for a great bull market that would turn into a great mania, which ultimately fully retraced.”

Fully retraced?

That’s part of the lexicon of the man known for popularizing key theories of the Elliott Wave Principle (EWP). It was a set of theories first put forth in the 1930s by Ralph Nelson Elliott, who argued that people are rhythmical beings who go through certain waves of behavior. Those mass psychological waves affect the financial markets, Elliott said, and if you look at the history of the stock market you would see repeated patterns that were directed by that investor psychology. When people were optimistic about an investment, they bid the price up; when they were pessimistic about it, they bid the price down.

Prechter found the theories of EWP engaging. Perhaps it is not a coincidence that he graduated from Yale not with a degree in business or finance, but in psychology.

“I think that waves of social mood are causal to the market’s movements,” he says. “They are also causal to all social action, and they’re the engine of history. So fundamentals lag and follow waves of social mood. They are the result.”

Put another way, the fundamentals of corporations and the economy—such as earnings and gross domestic product (GDP) growth—do not cause the rise or fall of prices on Wall Street. Social behavior within a market does. That’s why Prechter, as a technical analyst, watches the wave movements of a market more than he watches the fundamentals of the economy.

“Fundamental analysis is information from outside the marketplace,” Prechter says. “For instance, let’s say the company’s earnings are ‘x,’ and the president’s policy is ‘y.’ And from this information we’re going to try to guess where the market is going. The technician is someone who studies information generated by market behavior itself. So he’s watching price movement, market psychology, the extent of optimism and pessimism. He’s looking at the speed and breadth of the market. He’s looking at volume—things that are internal to the market.”

It is here that Prechter sees the value of following wave patterns. “Wave patterns include all those things: sentiment, momentum, even volume observations. So it’s a 100 percent technical approach.”

Prechter first learned about Elliott Wave theory in the early 1970s, shortly after he graduated from college and began working with A. J. Frost. He was reading Richard Russell’s Dow Theory Letters, and in 1975 came across a copy of Hamilton Bolton’s book on the subject. He wanted to know more.

So he went to the library. And he searched for two books written by R. N. Elliott.

“The Library of Congress didn’t have them—I checked there first.” But he did find them listed in the card catalog of the New York Public Library. “They had both of his books on microfilm. So I paid them a few cents a page and had them print the books out. I spent about two years putting it all together.”

Was the information translatable from books written so long ago, in 1938 and 1946?

“Oh, completely!” he says.

That research, and his application of EWP, became the foundation for virtually all of his market analysis since. It began in earnest during his years as a technical analyst for Merrill Lynch in the mid-1970s, where people were only discussing the most basic ideas of how waves are formed.

He took that further, publishing his first Elliott Wave Theorist newsletter in 1976. The newsletter has been published continually since 1979. Prechter has gone on to write 13 books, formed Elliott Wave International (which publishes analysis on the financial markets), served as president of the Market Technicians Association, and created a theory of social mood called socionomics, in which he analyzes social trends based on mass psychological waves. To that end he has founded Socionomics International and the nonprofit Socionomics Foundation; written the book Socionomics; and lectured on the topic at major academic institutions, including MIT and the London School of Economics.

It all started with Elliott, and Prechter’s trip to the library.

“Most people,” Prechter says, describing the additional data he gathered, “talk about five waves in bull markets, and three waves in bear markets. But Elliott had many more details and reasoning behind it—many more examples and more comments about why he thought this was happening.”

His successful application of the theories paid off for him during the 1980s bull market, during which he won awards for market timing. The Financial News Network, now CNBC, named him the “Guru of the Decade” in 1989. And his predictions on the future of the stock market post-’87 crash were claimed by some to be so powerful as to move the markets (an assertion that Prechter considers ridiculous). In the months after Black Monday in October 1987, subscriptions to Prechter’s Elliott Wave Theorist surged to some 20,000.

But if there are waves in financial markets, so are there waves in business careers, and Prechter believes he has experienced ups and downs just like those in the stock market: “I’ve plotted them. I’ve plotted subscriptions.”

He got the equivalent of a bull market third wave by getting the 1980s right, but his predictions in the 1990s did not fare as well. And his consistently bearish tone during the roaring 1990s and into the 2000s created critics who considered his Elliott Wave theory less than legitimate technical analysis. He has frequently predicted stock market collapses, and picked lower levels in the major indexes that the stock market didn’t remotely approach.

Here’s how Eric Tyson, author of books such as Personal Finance for Dummies, puts it: “The underperformance of Prechter’s newsletter is nothing short of astonishing and stunning! On an annualized basis [from the beginning of 1985 to the end of May 2009], Prechter has underperformed the broad U.S. stock market Wilshire 5000 index by a whopping 25 percent per year!”

But Prechter defends his performance in a couple of ways. First, he says, “It’s a probability game. People in my business are trying to predict the future. And the quality of the predictions has to be considered. I don’t think anybody’s ever made the prediction of a mania like I did.”

And he also points out an improved track record in recent years. MarketWatch stated that the Elliott Wave Financial Forecaster (EWFF) was one of the few to make money during the market collapse in 2008. And in September of 2009, it cited success in the rough markets:

In fact right now, it looks like pessimism has paid off. Over the past 12 months through July [2009], EWFF is up 11.4 percent by Hulbert Financial Digest count, versus negative 20.03 percent for the dividend-reinvested Wilshire 5000 Total Stock Market Index.

Over the past three years, the letter has achieved an annualized gain of 3.58 percent, against negative 5.78 percent annualized for the total return Wilshire 5000. Over the past 10 years, the letter has achieved a 1.2 percent annualized gain, compared to negative 0.26 percent annualized for the total return Wilshire.

Part of what Prechter got right was the cataclysmic peak of the stock market in 2007. He says it was a classic fifth wave top. And for those who say the peak was reached because of easy money, Prechter agrees. But he says the easy credit was the result of the public mood toward money.

Credit doesn’t come from nowhere. It doesn’t come from the Fed. It was when we finally got into the fifth wave that the debtors said, “I want to borrow because I’ll have no problem paying it back,” so they were optimistic. And the creditors said, “We trust these people to pay us back. Even if they’re broke, and they want a house, we’re willing to finance it.” And I think such extreme optimism is almost as if these people weren’t thinking.

Prechter looks at the current point of his career as the beginning of a soaring bull stage. “The good news is I’ve actually got to get a fifth wave and I think things are improving now. I’m deeply in it.”

His career is marked by great ups and downs in stock market prognostication, but an element of his experience that is not often examined is his market-forecasting firm, Elliott Wave International. His best mistake, in his mind, happened during the bear phase of his career.

“I was in a wave four,” he says, “a long-drawn-out period. And amazingly, that crisis [his “best mistake” story] came right at the end, which is just what happens in the world of stock market patterns—you get the recession or the war at the end of the correction.”

Bob Prechter’s Best Mistake, in His Own Words

In the early 1990s, the retail investment publishing business was fading, and I decided to counter the trend in declining revenues by having my company, Elliott Wave International, publish analysis for institutions such as banks, insurance companies, and pension funds. As it turned out, institutions became kings in the 1990s, so this decision kept us growing vvhile many retail-only analytical services were going out of business.

To start this new division, I hired outside analysts who specialized in various markets—for example, currencies, interest rates, and international stock markets. We built slowly but persistently toward 24-hour coverage of all major markets around the world. I did the hiring bit by bit, as we grew.

In order to sell these new services, I had to build a sales department, because institutions rarely respond to marketing but prefer phone calls, presentations, and personal visits. To attract the initial people for this start-up venture, I paid the first analysts high salaries and set up some participation agreements. If we succeeded, their pay would go way up. It was how I would have wanted to be paid if I were on the other side of the desk.

As the retail side languished, our institutional side grew. By 1999, we had about a dozen analysts covering institutional services and as many full-time sales personnel. But sometimes persistent growth breeds feelings of entitlement.

Dissatisfaction in the institutional division began in the second quarter of 1999. My CEO had resigned earlier that year, and I began to take stock, finding practices I didn’t like and reining in bloat. For example, the sales department was taking overseas sales trips that chalked up expenses for fun times yet brought home few usable leads. I found bills for triple cappuccinos, in-room minibars, a bullfight, a golf club, and a limo ride. Still, I believed that their justifications were sincere and did not suspect a malicious mind-set. The head of sales, I later learned, did not appreciate the new oversight.

Around the second quarter of the year, we had a small dip in sales. The analysts with the highest incomes resented the slip of a few percent in their participation pay. Their attitude made no sense to me, as I knew they could not earn equal paychecks elsewhere. I did not imagine that reasonable people would have a negative reaction to such a normal event. But some of them had taken out large mortgages and had otherwise gotten used to having money flow in at an increasing rate. This shift in conditions turned out to have immensely negative implications for these employees’ attitudes toward me and the company.

Around this time, the head of sales and a highly placed analyst, despite the existence of restrictive covenants, began plotting with a competitor and some shadowy financial-business people on how to steal my institutional division. They began by cooking up a get-rich scenario with which to woo the rest of our institutional analysts and salespeople. They would form a new company and give each of them shares. To get the analysts on board, they spent the summer subtly frightening them into believing that my company was going under. The slip in revenues and pay for one quarter and then the next apparently made the claim sound plausible. Later, we found a deleted e-mail from the head of sales telling analysts that they might not get paid for the then-current period but that he was fighting for their rights and well-being. We later learned that he privately advised them not to ask me about the company’s downhill slide because I would just lie about it. Paranoia gripped many of the institutional analysts, all entirely unbeknownst to me. None of them came to talk to me about it, because they were told that any defectors would be barred from working with the new group. Members of this chosen group, they were told, would get unbelievably rich after the coup, while I would go almost immediately bankrupt. In other words, anyone who ratted or stayed behind would lose his job. The combination of threat and opportunity placed a very effective clamp on people’s tongues.

The plotters put together a plan to steal our customer list and take all our key institutional-division employees simultaneously. They rented hotel space to hold a secret meeting. The external confederates flew in and made a PowerPoint presentation detailing how rich they would all become. It all rested, they said, on keeping quiet until the time came for the key analysts and salespeople to leave all at once, making my company’s Internet analysis suddenly go dark, thereby forcing me to send refunds to all of our institutional customers. This way, I would go broke and be unable to fund a fight. I would also have to lay off almost everyone else in the company. Then the salespeople, set up in the new office, would rush to call all of our old customers, telling them to begin sending their checks to the new group, where all of our institutional analysts now resided. The competitor would supply the seed money. The group already had a lease on an office in a nearby community and had started equipping it with phones and computers. On paper, it seemed like a pretty good plan.

But it had a couple of flaws. The first flaw was that the leaders were arrogant and insisted on leaving behind the people they didn’t like or that they had dismissed as incompetent. As I later reeled from the first three unexpected resignations, one of the two excluded salespeople caught wind of the plot and started asking questions. (He is now a company director.) The second flaw was a decision that seemed fiendishly clever: Twenty employees would tender resignations one by one during the last three days of the final week in October, giving an end date of Friday, which meant giving essentially no notice so as to cripple the company in one swoop. They would give phony stories of where they were going, and why, to make it appear, at least at first, as if the decisions had been made individually. They made up these stories and carefully chose the date to ensure that everyone leaving that Friday would get paid full salaries and bonuses for the month, not only to give all of them maximum income but also to weaken the company financially. But this timetable ended up turning what would have been a total surprise into only a near-total surprise, and that difference was crucial. I learned about the plot shortly after the third notice—on Wednesday—of a Friday termination. So, their desire to dissemble their intent by staggering the resignations, but more important to get paid on Friday, gave me one business day to figure out what to do and how to do it.

By pure luck, a highly competent lawyer friend who often travels was in town and available. We spoke on Thursday as more resignations came in. On his advice, on Friday morning I quietly set him up, along with one of his colleagues and three loyal directors from other departments, in a corner office by a stairwell. As the resignations came in, I told each resigning employee that he could collect his paycheck from the accounting department after participating in an exit interview, which was standard procedure. But in this case the interview was designed to learn what was going on. After the first person was interviewed, he was escorted down the stairwell and told not to return. To make sure those already gone could not call in warnings (this was before the era of cell phones), we shut down the office telephones and announced a breakdown of the system. The information technology (IT) department bustled around as if trying to fix it. Upon each new resignation, I chatted calmly with the employee, awaiting the signal that the interview room was available. Some of the conversations had to go on for an hour. It was a grueling day, but one by one, over the course of a 12-hour day from 9 A.M. to 9 P.M., the departing people were processed until we had all the information we needed. Knowledge of the stolen customer list gave us enough to take before a judge the following Monday and ask for a 30-day injunction on the group’s actions, which he granted.

Still, the institutional division was decimated. We had only one salesperson left, as the one who had discovered the plot was now deployed elsewhere. Fortunately, someone who worked in another department expressed a strong desire to move to sales, so then we had two. (This person turned out to be our top salesperson within a year.) We transferred all the accounts to the two of them. They had to work long hours to service the larger number of customers per person, but they were fine with it because it meant a good paycheck.

We had only a few institutional analysts left, and few of them were equipped to do the level of coverage required. But we raised their pay, moved them to double shifts, and had the retail analysts chip in with overtime as well. A market-seasoned employee from another department wanted to be an analyst and volunteered for one of the vacant positions. We cut portions of institutional services we thought readers could do without and sent out a call to hire new analysts. We hired two within days. We got some complaints from customers during November, as our market coverage was noticeably thinner. We issued a few refunds and subscription extensions, but our coverage was enough to squeak by during the month of severest stress. When December arrived, markets calmed and some customers took vacation time, giving us a slight breather. From there, we built the department back up, one analyst at a time. Eventually, we even hired back a few of the analysts who had left once we determined that they were more victims than perpetrators of the hijacking scheme.

The rest of our employees realized that the plot, had it been successful, would have immediately forced them out on the street, and they were furious about it. They were also focused and determined.

As it turned out, the head organizers who had so deftly persuaded everyone to join their plan had failed to set up the new office properly. Despite having two months to equip it, the phones weren’t working and the computers weren’t online. Nor did the promised money materialize. When the judge ordered the group to return our customer list, the outside business people slipped back into the woodwork and stranded their compatriots. Later it became clear that the promise of riches had been vastly overstated even if the plan had worked flawlessly. In the end, we went to mediation, and most of the main people involved agreed to pay enough to cover our legal fees in order to avoid going to court. The episode still cost us a lot of money and brought our company to the brink of disaster. But the in-house perpetrators’ and their followers’ lives were a mess, too. They went from making high salaries to zero. It was an exhausting time.

I blame myself for a good deal of what happened. Obviously I was not in close enough touch with the employees in these two departments. As a market analyst myself, I had friends among our analysts and was always loyal to them, so I was unprepared for their susceptibility to paranoia and willingness to conspire in secret. However, I had never warmed up to most of the salespeople. We talked and had a few laughs, but we weren’t buddies. Had I been closer to them or more aware, perhaps I could have averted the disaster. This was my biggest mistake in 30 years of managing my company.

But you know what? It turned out to be a great mistake. A few months later, my lawyer made an observation: “A bunch of overpriced analysts quit, and now you can replace them at market rates.” He was right; it was a major silver lining. But that proved to be only half the boon. As it turned out, 1999 was the top year for institutional business. From 2000 to 2003, as the markets fell and the economy went into recession, the entire institutional-analytics industry experienced a flood of service cancellations. It got so bad that our two biggest competitors, whose only business model was selling analysis to institutions, closed their doors. Meanwhile, our retail division was growing again thanks to the market downturn, and we maintained sufficient income to weather the institutional contraction. Within a short period of time, it became clear that we needed only a few salespeople after all. Our new analysts, all good people, were happy to be here and had no presumptions of entitlement. In most cases, they did better work than the people they replaced. And the lower overhead allowed us to keep the high-level coverage going out.

Then I realized an amazing thing: Given the worldwide collapse in institutional business in 2000—2003, the high cost of our analytical and sales departments under the old model would have driven the whole division into the red. The attempted coup had in fact cleared the decks for us. As a result, I avoided the pain of having to deal with the problems and resentment that would have attended the contraction of the division and the necessary spending cuts that would have gone with it. Soon afterward, I decided that our future was in marketing, not sales, and proceeded to bring in good people to expand our marketing team. A few years later, I dissolved the sales department entirely, finding other slots in the company for the people who had kept it going. As horrible as the three months following the attempted coup had been, the swift contraction in these departments probably saved the company from having three difficult years. In retrospect, the timing of the coup was a subtle sell signal for institutional business, as the organizers had operated on the foregone conclusion that the old uptrend would continue apace, which is exactly how people think when a financial market is topping out.

When the dust had settled on this incident, I started a program of e-mailing in-house company news—covering good news and bad as soon as we had it—to every employee. I didn’t want them to hear anything at the water cooler that they had not already heard from me. And when they did hear something that didn’t sound right, they would know it. We still offer high-level market coverage, but we no longer play the game of traveling, presenting, entertaining, generating sales commissions, and all the other stuff that goes with it. On the Web we built a simple menu for subscriptions under which anyone who wants to can subscribe to what we call our Specialty Services. We sell them through low-key, opt-in marketing. This also helps us keep prices down.

The old sales model flat-out died. But instead of my having to kill it, it committed suicide. All in all, in the end, it was not a disaster but a relief.

Today we have more good analysts, better marketing, and consistent growth. I will always be thankful that I started the institutional division, because it kept my company prosperous during a decade of sharply shifted focus in the financial services marketplace. But I am even more thankful that it blew up. It’s a good thing I was too dumb to see it coming.

About Robert Prechter

Robert Prechter has written 13 books on finance, beginning with Elliott Wave Principle in 1978, which predicted a 1920s-style stock market boom. His 2002 book, Conquer the Crash, predicted the current crisis. Prechter’s latest interest is a new approach to social science, which he outlined in Socionomics—The Science of History and Social Prediction, published in 2003. In July 2007, the Journal of Behavioral Finance published “The Financial/Economic Dichotomy: A Socionomic Perspective,” a paper by Prechter and his colleague, Dr. Wayne Parker. Prechter has made presentations on his socionomic theory to the London School of Economics, Georgia Tech, MIT, the State University of New York (SUNY), and academic conferences.