Many investors understand that peaks in confidence are the time to get out of a market and take cover. But to have that knowledge is one thing, to use it is another. This where the Elliott Wave Principle makes the difference: it provides the why of market psychology, and can even help identify the all-important when. The "why" is straightforward: When everyone's optimistic there's nowhere for a market to go but down, and the trend reverses. In turn, at the very bottom of a trough, investor confidence can only rise (and with it, stock market indices).
As for the "when," Germany's DAX has recently been a good example. According to the IFO Institute's Business Climate Index, confidence among German executives hit a 13-month high in October. Sounds like great news... until you consider that the last time they felt this upbeat was around Lehman's bankruptcy filing. This same index hit a 26-year low in March, after which the DAX began a recovery bounce that we're still riding. Whether on the verge of a collapse or a wave up, most investors will be too caught up in the social mood trend to see what's really going on.
As Bob Prechter put it in The Wave Principle of Human Behavior:
. . . sentiments among both the public and financial professionals wax and wane concurrently with the trend and level of the market. This tendency is not simply fairly common; it is ubiquitous . . . They are driven to follow the herd because they do not have firsthand knowledge adequate to form an independent conviction, which makes them seek wisdom in numbers. The unconscious says: you have too little basis upon which to exercise reason; your only alternative is to assume that the herd knows where it's going.
Because stock market indices reflect social mood, forecasters who watch that mood can anticipate the trends and turns in price. This perspective can change the way you watch the news. In that light, the string of resignations in Berlin last week become very interesting.
Three major military figures (top soldier Wolfgang Schneiderhan, Deputy Defense Minister Peter Wichert, and former Defense Minister Franz Josef Jung) resigned amid allegations of a cover-up related to a NATO air strike in Afghanistan. The resignations themselves aren't that surprising; it's a front-page scandal, and the evidence has been damning. More interesting is how the German press covered the resignations: new stories have been full of vitriol. Left-leaning, centrist and conservative papers; tabloids; and even business dailies have been vicious about affair, particularly Jung's role in it. That kind of consensus means the issue is no longer political, but broadly social. Add the fact that German investor confidence is declining even faster than economists predicted, and it amounts to a social mood that looks grim.
What does it mean when big business is feeling confident while the investing public is skeptical? What differentiates a bull market "wall of worry" from the turning point in a bear-market rally? The
European Financial Forecast reads the signals that mark the turns.
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