In Elliott wave patterns, third waves represent the strongest part of a stock market's trend.
Elliott Wave Principle put it this way (p. 80): "Third waves are wonders to behold...[they] usually generate the greatest volume and price movement..."
This description applies to bull and bear markets alike.
Yet time and again, experience shows that when third waves begin, investors are psychologically unprepared.
For example, consider the third wave launch on July 25, 1984. The market had rallied in 1982-1983 but pulled back from early 1984 into July:
"One might think that after the surge of 1982-83, investors would have adopted a long term bullish stance...But even after the market popped sharply in July as wave (3) of 3 began, investors were cautious. The market continued to rise for another entire year, yet investors remained more concerned about downside risk than about upside potential. In the summer of 1985, the averages made a new all-time high, yet investors still did not embrace the advance."
Elliott Wave Theorist, February 2011
Prechter knew investors had not embraced the advance because he had reviewed market sentiment gauges.
The mid-1980s market advance defined that decade's powerful bull market, yet investors were cautious for much of that time.
Another example is the start of a third wave in 1975, with the strongest part of that wave (third of a third) arriving in 1976. The same Theorist issue said, "...individual investors were so market-averse that they were selling mutual fund shares at what was then the highest rate on record." Please take a look at the chart below:
Many mutual fund investors sold their shares at precisely the wrong time.
As noted above, third waves also unfold in bear markets. That's when prices typically have their biggest moves on the downside. But as with bull markets, investors are likewise caught off guard by the bear.
Consider that 2012 has started with a burst of investor optimism, even though the S&P 500 was flat in 2011:
"Forecasts by individual analysts for S&P 500 member companies, if added together, would have the benchmark index jumping 16 percent this year."
CNBC (1/3)
Are investors once again mentally positioned on the wrong side of the market, like in the examples of the 70s and 80s -- with the difference that a bear instead of a bull trend is unfolding?
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