If you’ve been reading this column for a while, you’ve most likely found our views different from what you normally see in the mainstream financial media. You may be curious about how we do our analysis and come up with our conclusions…so here’s a quick peek at our know-how.
The unorthodox economic and social perspectives we present here are based on the Elliott Wave Principle. Its main hypothesis – and the hardest one to swallow – is that mass human behavior is patterned. And since it is patterned, it is predictable.
This assertion goes against most mainstream economic theories, which claim that markets are random and unpredictable. The dominant theory among these is the efficient market hypothesis. First proposed in the 1960s, it states that the price of market securities is always “efficient” – i.e., correct – because investors are all rational beings that make decisions upon rational considerations. Therefore, prices can never be too high or too low – they are always “just right.”
You can see why this view of the financial markets is so appealing. Every person considers him or herself a rational individual who makes decisions independently, free of any emotional influences. No one wants to admit that – yes, $450 for a share of Google, or $545 for an ounce of gold, or $700,000 for a one-bedroom condo may be “too high, but...everybody’s buying them.” And under the efficient market hypothesis, the price is never “too high.” It can’t be. Which is a very comforting thought.
Elliott Wave Principle says that prices are inefficient, because they are a function of psychology. Individuals can be quite rational, but groups and crowds are not; they are emotional. The actions of one individual are unpredictable, but when we find ourselves in a collective environment – a sports stadium, for example – our actions lose their individuality. When 50,000 fans watch the same football bouncing around the field, collective psychology takes over, behavioral patterns emerge, and the fans act predictably. When their team scores the fans go wild, and when the tables turn they get angry and depressed.
In the financial markets – which are nothing but large crowds of investors buying and selling – mass emotions swing from one extreme to the other in exactly the same way. When millions of investors watch the price of the same security bounce around, collective psychology takes over individuals’ rational impulses. That’s why most investors simply end up copying the actions of others, regardless of whether or not it’s rational to do so. This cartoon has been around for years, but it illustrates this point perfectly:
First Trader: “I’ve got a stock here that could really excel.”
Crowd: “Really excel?” – “Excel?” – “Sell?” – “Sell, sell, sell!”
Second Trader: “This is madness! I can’t take this any more! Good bye!”
Crowd: “Good bye?” – “Bye?” – “Buy, buy, buy!“
Fortunately, shifts in mass investor psychology, however illogical, occur in recognizable Elliott wave patterns. And once you learn to spot them in the markets, you’ll also learn to forecast them. Get started right now – just take a look at our latest European research, for example. It’s risk-free, as always.