The Stock Market: Meet the New Boss (Same as the Old Boss)

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The Stock Market: Meet the New Boss (Same as the Old Boss)
Learn what really governs stock market prices

By Bob Stokes
Fri, 22 Jun 2012 17:00:00 ET

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Portfolios suffer severe bruises because many investors believe that news and events drive stock market prices.

When these market participants act on financial headlines and ignore the real boss of the market's trend, they almost always get into financial trouble.

Take these recent headline events that no-doubt led many investors astray:

A headline from the Wall Street Journal website reads:

Moody's Downgrades Global Banks – WSJ, June 21

Yet here's the headline that's published the very next day:

Banks Lead Stocks Higher – WSJ, June 22

In other words, bank stocks performed in the opposite direction that most investors would have expected given the bad news – they went up. For instance, Morgan Stanley was downgraded two notches to BAA1 from A2, but its shares rose 3.3% to $14.42 in late trading, after dropping 1.7% during market hours.

The reported reason for the disparity between expectations and reality? The downgrades weren't as extreme as most investors expected.

Next, take the Federal Reserve's June 20 announcement that it will extend Operation Twist until year's end. Of course, Operation Twist is the nickname for the Fed selling short-term securities and buying the same amount in longer-term securities in an attempt to reduce borrowing costs and stimulate the economy.

If you believe news drives stocks, you have no choice but to expect the announcement would calm investors' fears and cause them to buy. And this headline would support that line of thinking:

US stocks rise on hopes Federal Reserve will extend Operation Twist – Global Post, June 19

However, three days later, you would be forced to observe that the Dow Industrials sank 250 points after the Fed's announcement – prompting headlines like:

"Operation Twist" Sends Global Equities Into a Tailspin – AOL News, June 22

Now, take the Facebook IPO for yet a third example.

There was a lot of hype about the Facebook IPO, like:

Facebook IPO sparks dreams of riches, adventure – Reuters, April 8

and …

Will Facebook's IPO Smack Down Apple? – MSNBC, April 18

Yet a lot of speculators lost a lot of money in the weeks after the social media site's May 18 trading debut.

Two weeks before the IPO, The Elliott Wave Financial Forecast observed:

The market is a long way from the all-out frenzy of 2000 when hundreds of IPOs routinely doubled in their first day of trading. Many of the highly celebrated offerings of 2011 and 2012, such as Zynga and Groupon, have sunk below their initial offering prices. Applying the Wave Principle to the Bloomberg IPO Index suggests that conditions will worsen in the near future. After retracing a Fibonacci 61.8% of its February to October 2011 decline, the IPO Index topped on March 27 and appears to be resuming its downtrend. Facebook’s IPO is still to come … But Facebook faces an even bigger growth problem than Apple. With 900 million users and tiny profits by comparison, it will be hard to add more users at rates that will alleviate concerns about a sky-high stock market valuation.

As The Wall Street Journal reported June 15, "Facebook capped its first four weeks of trading as the second worst $1 billion-plus IPO of all time, according to Dealogic."

All of these examples serve as valuable references for anyone considering news-driven fundamental analysis vs. psychology-driven technical analysis.

It seems logical that hype, news, market opinions from prominent people, government and Fed actions and other events would steer the stock market's trend. And it's true that the markets sometimes have a knee-jerk reaction. But when you look at the price charts that reveal the overall trend, you can easily see that none of these much-hyped news events have a long-term impact on share prices.

Technical analysts know that the real boss of the stock market is mass investor psychology.

The Elliott wave method is a study of this mass psychology as it's reflected in the stock markets' price patterns.

Although it is the best forecasting tool in existence, the Wave Principle is not primarily a forecasting tool; it is a detailed description of how markets behave. Nevertheless, that description does impart an immense amount of knowledge about the market's position within the behavioral continuum and therefore about its probable ensuing path.

The Elliott Wave Principle, p. 19

Right now, the Elliott Wave Principle has identified a probable market turning point that may be as significant as the lift-off of the bull market in 1982.

Learn why EWI believes that U.S. markets are at a historically crucial juncture. Get two of our monthly flagship publications for only $29 via a special risk-free trial. Learn more now>>

Tags: Elliott Wave Principle, Facebook IPO, fundamental analysis, investment decisions, investor psychology, market myths, sentiment, stock indexes, technical analysis, U.S. Federal Reserve (the Fed)

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The Elliott Wave Principle is a detailed description of how financial markets behave. The description reveals that mass psychology swings from pessimism to optimism and back in a natural sequence, creating specific Elliott wave patterns in price movements. Each pattern has implications regarding the position of the market within its overall progression, past, present and future. The purpose of Elliott Wave International’s market-oriented publications is to outline the progress of markets in terms of the Wave Principle and to educate interested parties in the successful application of the Wave Principle. While a course of conduct regarding investments can be formulated from such application of the Wave Principle, at no time will Elliott Wave International make specific recommendations for any specific person, and at no time may a reader, caller or viewer be justified in inferring that any such advice is intended. Investing carries risk of losses, and trading futures or options is especially risky because these instruments are highly leveraged, and traders can lose more than their initial margin funds. Information provided by Elliott Wave International is expressed in good faith, but it is not guaranteed. The market service that never makes mistakes does not exist. Long-term success trading or investing in the markets demands recognition of the fact that error and uncertainty are part of any effort to assess future probabilities. Please ask your broker or your advisor to explain all risks to you before making any trading and investing decisions.