The Eraser: What's Behind All Those Disappearing Dow Points?

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The Eraser: What's Behind All Those Disappearing Dow Points?
Investor Psychology Moves in Waves: Every Minute, Every Day, Every Year

By Bob Stokes
Wed, 16 Mar 2011 15:45:00 ET

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All investors -- including experienced professionals -- must simultaneously grapple with two enemies: 1) Imperfect knowledge, and 2) Their own emotions. So what do the vast majority do?

They unconsciously look to other investors for clues:

"Wall Street certainly shares aspects of a crowd, and there is abundant evidence that herding behavior exists among stock market participants.... Most people get virtually all of their ideas about financial markets from other people, through newspapers, television, tipsters and analysts, without checking a thing. They think, 'Who am I to check? These other people are supposed to be experts.'... This dependence is nearly universal, even among long-term investors.... Outwardly, they appear rational. Inside, their unconscious is in control....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."

The Wave Principle of Human Social Behavior, p. 153

Thus when the herd is bullish and buys, stocks go up. When the collective psychology is "bearish" and the herd sells, stocks go down.

So: when it comes to recent stock market declines, the real "Eraser" is a bearish collective psychology among the investing herd.

Alas, most investors are simply not aware of this larger psychology. They believe news or outside events drive market prices. But let's examine this assumption. If it were true, market prices would unfold in a pattern much like what you see on the chart below:

We know this is not how price patterns appear. Why not? Because "events" like those in the chart do not drive stock market trends -- contrary to common belief.

Economists have searched high and low for the "events" which supposedly triggered everything from the 1929 Crash to the 1987 Crash to the "Flash crash" this past April.

Yet they still can't reach a consensus on what caused these and other major market moves, because they investigate almost everything except the true cause.

"Economists of all stripes have tried to come up with an explanation for the 1987 crash. Yet in a 1991 paper, four years after the fact, William Brock studied economists’ commentaries and concluded, 'In my opinion, no satisfactory explanation has been found [for] the most recent crash…Black Monday, October 19, 1987.'

"What about the most devastating event of the 20th century, the Great Depression and the collapse in stock prices that led to it? The Winter 1999 issue of the Federal Reserve Bank of Minneapolis’ Quarterly Review observed, 'Economists and policymakers are still studying and debating what caused this catastrophic economic event.'"

Elliott Wave Theorist, March 2010

So we return to the explanation that really does explain -- herding and collective mood -- and the investor behavior that flows from them.

The Elliott Wave Principle measures the trends in collective psychology. Moreover, decades of observation reveals that these trends (or waves) unfold in repeating patterns.

That's the key to probabilistic market forecasting.

So what does the Elliott Wave Principle reveal about today's market?

Now is the time to take your risk-free review of our Financial Forecast Service -- before a potential acceleration in the trend. You're under no obligation for 30-days. Learn more about the Financial Forecast Service.

Tags: 1929 Stock Market Crash, Bear market, Robert Prechter, Elliott Wave Principle, herding, investor psychology, S&P 500

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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.