There is always a mass psychology at work in financial markets, where investment craze can build and then erase billions of dollars from investor portfolios, such as during the internet stock bubble of the 1990s and the real estate bubble of the mid-2000s.
The main reason so many financial market participants lose money was expressed more than a century ago by Charles H. Dow, creator of the Dow Jones Industrial Average:
There is always a tendency on people’s minds to believe that the conditions that exist will be permanent.
The only thing that is “permanent” in the financial markets, however, is change.
The key to navigating the financial markets is finding a method that will help you Anticipate change. In other words, a method by which you can tell when a trend (whether up or down) is reversing.
Well, technical analysis, particularly the Elliott Wave method, provides an unbiased framework for analyzing market trends.
Here’s what Elliott Wave International President Robert Prechter said in his book Prechter’s Perspective:
The wave principle is a … description of the steps people go through when they are part of the investment crowd … The path they take from extreme pessimism to extreme optimism and back again is essentially the same and over, regardless of news and trivial events.
The basic Elliott wave pattern consists of impulsive waves (denoted by numbers) and corrective waves (denoted by letters). A pulse wave consists of five sub-waves and moves in the same direction as the trend of the next larger size. A correction wave consists of three sub-waves and moves against the trend of the next larger size.
As the following figure shows, these basic patterns combine to form ever larger five- and three-wave structures:
In a bear market, the five waves of the main trend would be down and the three corrective waves would be up.
It is important to note that the Elliott Wave Method offers no certainty – yet it is does provide highly reliable way assess the future development of the market.
This -plies to every widespread financial market in the world. Investor psychology is the same everywhere.
Find out what our Global Market Perspective has to say on 50+ global financial markets by following the link below.