The Manic-Depressive Stock Market: What to Make of It

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The Manic-Depressive Stock Market: What to Make of It
The psychology of the market may be teetering on the edge

By Bob Stokes
Thu, 26 Apr 2012 16:45:00 ET

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The stock market: one week it acts like Dr. Jekyll, the next week it's Mr. Hyde.

That shift can even occur in the course of a single session.

These dramatic fluctuations appear to be impulsive; and we know that impulse does not flow from cold reason. Even so, the Efficient Market Hypothesis would have us believe that investors are constantly applying reason and logic to reach some objective market pricing, via the latest news or measure of stock market valuation.

The February 2010 Elliott Wave Theorist provides insight:

The Efficient Market Hypothesis (EMH) and its variants in academic financial modeling...rely at least implicitly but usually quite explicitly upon the bedrock ideas of exogenous cause and rational reaction. Stunningly, as far as I can determine, no evidence supports these premises...

EMH argues that as new information enters the marketplace, investors revalue stocks accordingly. If this were true, then the stock market averages would look something like the illustration shown [below].

We know that the market does not unfold in the way illustrated above. But we do know that the market has unfolded like this:

So in 2000, did a sudden burst of logic lead investors to realize that the NASDAQ was over-valued?

No. Technology stocks had absurd price/earnings ratios long before the NASDAQ top.

The NASDAQ's abrupt switch from Hyde to Jekyll stemmed from investors' collective unconscious. Consider the gazelle that runs in panic because others are: it does not pause to rationally survey the landscape. It explodes in a burst of speed that reaches 90 km/hr within seconds.

Decades ago, multimillionaire stock market operator Bernard Baruch said

...the stock market is people. It is people trying to read the future. And it is this intensely human quality that makes the stock market so dramatic an arena, in which men and women pit their conflicting judgments, their hopes and fears, strengths and weaknesses, greeds and ideals.

This psychology of the marketplace unfolds in waves. That is what we study.

Our analysis is meticulous. Even so, the rules and guidelines of Elliott Wave analysis sometimes present alternative interpretations. We're now looking at two. One price path appears most likely.

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Tags: Bear market, Efficient Market Hypothesis (EMH), Elliott wave, herding, investor psychology, market crash, market forecasts, Nasdaq Composite, risk management, Robert Prechter, U.S. STOCK MARKET, volatility

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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.