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How to Use Investors' Collective Unconscious to Anticipate Stock Market Trends
Learn the steps human beings go through when they're part of an investment crowd

By Bob Stokes
Mon, 12 Nov 2012 16:15:00 ET
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The unconscious mind of an individual can deliver breakthrough insights. 

Some are well-known.
 
Consider the Beatles song, Yesterday. Paul McCartney awoke with the tune in his head. The song became a big hit, one of the most widely recorded by other artists.
 
James Watson saw the shape of the DNA molecule when he dreamed of two snakes intertwined in an ascending helix form.
 
In 1838, Charles Darwin had been trying to figure out the process of natural selection. The famous scientist wrote in his autobiography, "I can remember the very spot in the road, whilst in my carriage, when to my joy the solution occurred to me."
 
These are a few examples of when the unconscious of individuals yielded profound results.
 
But there's also such a thing as a collective unconscious. One example is brainstorming, where a group of people gather to discuss the solution to a problem or goal. The interaction may stimulate a member of the group to come up with a breakthrough the rest of the group can rally around.
 
Other manifestations of the collective unconscious are less productive, or downright extreme. Examples vary from violent mobs like we've seen recently in the Middle East to social and financial manias like the Roaring Twenties and Beatlemania.
 
Mass psychology is always at work in the financial markets, where investment frenzies can build up then erase billions of dollars from investors' portfolios, like during the Internet stock bubble of the 1990s and the real estate bubble of the mid-2000s.
 
More than a century ago, the creator of the Dow Jones Industrial Average, founder of The Wall Street Journal and co-founder of Dow Jones & Company wrote:
 
There is always a disposition in people’s minds to think the existing conditions will be permanent. When the market is down and dull, it is hard to make people believe that this is the prelude to a period of activity and advance. When prices are up and the country is prosperous, it is always said that while preceding booms have not lasted, there are circumstances connected with this one, which make it unlike its predecessors and give assurance of permanency. The one fact pertaining to all conditions is that they will change.
 
Charles H. Dow
 
Peaks and troughs in investor psychology have repeated throughout the stock market's history. Investors who can recognize the current trend for what it is are the best prepared to anticipate and benefit from its eventual reversal. So the question becomes, how do you recognize the current trend for what it is?
 
Technical analysis, particularly the Elliott Wave Principle, provides an unbiased framework for analyzing market trends.
The Wave Principle is a catalog of the ways that the crowd goes from the extreme point of pessimism at the bottom to the extreme point of optimism at the top. It is a description of the steps human beings go through when they are part of the investment crowd, to change their psychological orientation from bullish to bearish and vice versa. That description fits the movement of any market, as long as human beings are involved …. Since this aspect of people doesn’t change, the path they follow in moving from extreme pessimism to extreme optimism and back again is essentially the same over and over and over.
Robert Prechter, Prechter's Perspective
 

 

 

 

 

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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.