"The Market Secrets Experts Don't Want You To Know About."
Graham A.Dyer
It took me many years, if not decades, to grasp this concept, so don't be alarmed if you have any difficulty. But it is very exciting (not to mention incredibly rewarding) once you do, and well worth the effort. And I have done all the ground work, so it won't take you nearly as long.
First let me set the record straight. I did not "discover" this secret. I set out to d..... well find it! I had a fire in my belly to do so. What put that fire there? In 1970 I lost my life savings. First I sold my house too early. After trying for a year without success I dropped the price in order to find a buyer. Had I waited three more years I would have received triple the price.
Then, with a handsome capital gain from the sale of my house I plunged into the booming stock market. A year later I had lost the lot.
What the f ...? How could that happen? Especially to someone as "smart" as me. I was not your average Joe, for crying out loud. I was a qualified accountant (now called CPA)! How could someone so "clever" get it so wrong?
And so I set out to find what it is that makes financial markets (shares, real estate, gold, etc.) go up and down. And I wasn't going to rest until I did. I read every finance report and magazine I could get my hands on. But it was obvious that economists were no closer to the mark than I was. At one stage a few years later I thought I had found the Holy Grail. But alas that too was wrong. If necessity is the mother of invention, then financial loss is the mother of "discovery."
Finally I found it. It was like discovering for the first time in my life that the earth is round, when all of my life I had believed it was flat. It was like finding out for the first time that Santa Claus is not true. Everything I had been taught about economics and financial markets was totally back to front.
Getting my head around the new concept was hard enough. But nowhere near as hard as getting rid of the old preconceived ideas that were based on everything I had ever been taught. These are the same things you were taught at school and college or university and are now being fed every day in the media. Things you never question. You take them for granted. Yet they are all wrong.
I am now going to pass my "secret" on to you for free. It is not so difficult after all, now that you have someone to guide you (I wish I had had someone to guide me), but I warn you to keep your mind wide open, as this is going to require a sea change in your thinking. It is as natural as "the birds and the bees," yet at first just as mysterious.
The Pulsating "Rhythm of the Universe"
So called "nature" is remarkably patterned. It consists of endless tiny patterns within larger patterns within even larger patterns and so on. We call this "fractal" patterning. (The Bible talks about "wheels within wheels" in heaven - Ezekiel).
For example, our solar system consists of a central star and planets rotating on their axis, revolving around the sun in orbit, never crashing into each other. If we could examine an atom under a microscope, I am told we would see a central nucleus with electrons flying around it in orbit, never crashing into each other. Same pattern; all that is different is the size.
Take a broccoli bush. Pull off one head. It's the same shape as the bush, only smaller. Now pull off a smaller segment. It's the same shape as the head, only smaller. Once again, same pattern; all that's different is the size.
We see this patterning everywhere in nature. Sometimes the patterns are precise. Like moon phases and tide times. Others are unmistakable but not so precise. For example, you will never mistake a tree for an elephant or an airplane, yet no two trees are ever identical. The reason you recognize it as a tree is because of its pattern, rough though it may appear to be.
Now consider the worm, which can only move so far forward before he has to pull back so that he can go forward again. There is also a pattern to his journey. He progresses a certain distance, then must regress a certain distance. After that he can progress forward again. Each time he goes forward, the distance he progresses is greater than the distance he travels in regression (backwards), so the net effect of his effort is to move forward.
Should we be surprised if human history exhibits the same pattern? No. And that is exactly the pattern that is reflected in the share market. Yet we ignore this fact every day. I certainly had no idea it was relevant in 1970. Economists and the media which quote them still haven't got a clue. No wonder they did not label the last Great Depression as such until 1933, four years too late to save people from financial ruin. They won't recognize the next one either. You will if you follow my directions.
Let me now try and explain how all this (fractal patterning, progression, regression, etc.) relates to financial markets.
The Madness of Crowds
When people gather together in a crowd, that crowd takes on its own personality, separate from the individuals that make it up. And crowds behave differently at different times. They go through different moods. Sometimes a football crowd can be quiet and well behaved. At other times that crowd made up of the same people can become boisterous and unruly. A concerned public gathering can turn into a lynch mob. Individuals will do things as part of a crowd that they would never even contemplate doing alone. A quiet little grandmother or a timid office clerk can turn into a raving lunatic at a sporting event or a rock show.
Crowds panic. Fire breaks out in a cinema and people are trampled to death rushing the exits or die from smoke inhalation. Yet they could have all got out safely if they had not panicked.
You may have heard it said that "people go mad in crowds."
In his 1841 book "Extraordinary Popular Delusions and the Madness of Crowds," writer Charles Mackay quotes the ancient German philosopher Friedrich Schiller:
"Anyone taken as an individual is tolerably sensible ... as a member of a crowd, he at once becomes a blockhead."
Bernard Baruch (1870-1965), famous American financier and presidential adviser, is reported to have avoided losing millions in the 1929 stock market crash by remembering this important truth. He later said:
"All economic movements, by their very nature, are motivated by crowd psychology, which has the power to unexpectedly affect any static condition or so called normal trend."
Mood Governs Events
What does that mean? It means that when the prevailing mood of a crowd changes, everything that happens after that is a consequence of the mood change, not the other way around. For example, if the crowd throws bottles and other missiles on to a football field, it is not the throwing of things that made the crowd angry. On the contrary; they threw the items because they were already angry. The mood change came first. The throwing (the "event") came later.
The reason mainstream economists and other "experts" get it wrong so often is because they put the cart before the horse. They believe that events govern mood, when the opposite is the case. They say some "event," such as a rise in interest rates or a flare up in the Middle East, "causes" the market to "react," either positively or negatively, and thus people buy or sell stocks or houses or gold, etc. That is entirely back to front. That is like saying the throwing of bottles on to the football field (the "event") "caused" the crowd to "react" and become angry.
If interest rates rise or fighting breaks out in the Middle East, it is because of a change in mood that came first, not the other way around. In the case of the interest rate rise, because consumers felt optimistic and were borrowing and spending too recklessly, the central bank raised interest rates to try and curb the excess demand, which could lead to inflation if allowed to continue. But once again the public mood change came first. The "event" (rate rise) came later. It is the central bank who "reacts," not the public. The mood change in the ‘herd' caused the authorities to react, not the other way around.
Are you beginning to see that a study of financial markets should not be a study of what the government is doing, or what the central banks are doing, or what "events" are being reported in the news, be they economic or geopolitical? Rather it should be a study of the mood of the crowd, because it is only when that underlying mood changes that "events" occur later. Focusing on the "events," as the media does (and as economists do), is focusing on the symptoms, not the cause.
Can you also now see why property prices doubled in 1988 when economic fundamentals never changed? All that changed was the mood of the crowd in the real estate market.
Crowd mood is patterned
And here's the crucial (and exciting) breakthrough.
I mentioned earlier that when people gather as a crowd, that crowd takes on a personality of its own. The people in the share market constitute a crowd. Buyers and sellers in the housing market constitute a crowd. Likewise the market for bonds, gold, oil, etc. They are all crowds. Each of those markets (crowds) has an underlying mood. And remarkably, that crowd mood has a pattern to it! The mood changes from optimism (progression) to pessimism (regression) and back again in recurring waves of small and large and even larger degrees. Just like the worm's journey - forwards, backwards, forwards.
No matter whether you are looking at a chart for the last 30 minutes trading on the floor of the New York Stock Exchange or a chart of the share market for the last one hundred years, you will see the same pattern. There are small waves within larger waves within even larger waves, etc. etc. (Fractal patterning, like the broccoli).
And like the worm's progress forward, the human ‘herd's' progression through history is interrupted by periods of regression, which must be endured before the next move forward can be made. We go through periods of optimism which turn to pessimism and then back to optimism again. That is what is reflected in the share market chart.
What causes the change from optimism to pessimism? Nothing. There is no (apparent) cause. It just happens. It is part of the pattern. It is the "rhythm of the universe." What causes the moon phases? They just happen (apparently). Likewise the mood change in crowds. Crowd mood phases may not be as precise as the moon and tide times, but they are just as certain. We call this less precise pattern a "robust fractal."
What certainly does not cause crowd mood to change from optimism to pessimism or vice versa is any "event" in the "news." On the contrary, that "event" is a consequence of the mood change which comes first. An "event" may temporarily buffet the market. But it cannot change the underlying mood. And "reaction" to an "event" will prove to be short lived and always fully retraced.
Want a classic example? Do you remember when Wall Street was closed for a week following "9/11" in September 2001? The Dow Jones index had already been heading south for months. In fact, a study of the underlying mood pattern suggested it was approaching a turnaround. But everyone "knew" it would be a bloodbath once the New York Stock Exchange opened. And sure enough. As soon as it opened the Dow plunged, losing more than 1,500 points in the following week.
But do you remember what happened after that? The Dow then turned around and rose 2,400 points in the next three months or so! See how even an "event" as catastrophic as the historic terrorist attack on New York's "twin towers" produced a "reaction" that was only short lived and then fully retraced! Nothing can change the underlying mood of the ‘herd.' It is patterned.
Are you beginning to grasp how exciting and important this is? If there is a pattern to human crowd behavior, then if we study it, we should be able to predict what the crowd is going to do next. We can!
Why we get it wrong....
If it is as simple as that, why doesn't everybody know it, especially highly paid economists and other "experts?" Because to understand it you have to fight against human nature. And you have to fight against all the erroneous (in my opinion) information you have been fed which has "conditioned" you into accepting the mainstream consensus view without question.
I often tell my clients that investing is easy. You only have to remember one rule: Buy when prices are low; Sell when prices are high. It's that simple!
Yet it is human nature to do the opposite. When house prices, for example, are on the bottom, and have been there for years, nobody wants to touch houses. Real estate is a dirty word. But once prices have doubled, everybody wants to buy! Aren't we incredible? Why do we do this?
It's because of the part of our brain that we use to make investment decisions. The frontal neo cortex section of the brain, the logical, reasoning, rational part, is what we use for everyday decisions to buy and sell. For example, if we know gas is 10 cents a gallon cheaper four blocks away from our nearest gas station, we will drive the extra distance to make the saving. That's logical, rational behavior.
But when there is any element of speculation involved, we use the larger limbic system part of our brain. This part is driven by impulse and emotion. Hence we tend to do what everybody else does. We call this the unconscious herding impulse.
Think about that house you looked at a few years ago when it was $200,000. Why did you not buy it then? Because nobody else was buying, right? When it got to $300,000 you began to worry that you would "miss out" if you didn't buy soon. You finally went into enormous debt to buy it for $400,000. Now it is back to $300,000 and you are kicking yourself. You still have the huge mortgage, but the house is now worth less than what you owe on it. Did those decisions come from your neo-cortex? Was that sensible, rational thinking? No, that was emotional, impulsive, irrational, typical human behavior. You used the larger limbic system part of your brain to make those decisions.
You fell for the "safety in numbers" trap. Not consciously, but subconsciously. You bought because "everybody else was," so you felt safe. Yet nothing could be further from the truth.
We have an unconscious urge to herd, to "do what everyone else is doing." If "everyone" is wearing mini skirts, it must be "normal," so it is "safe" to do the same. If nobody is wearing the mini, we wouldn't dare be the odd one out. Can you see what I mean by the unconscious herding impulse? Can you see how it leads us to financial disaster?
But there is a wonderful upside to this phenomenon. It is the secret to knowing why and when financial markets are likely to go up or down. As humans go forward in waves of optimism (at times panic motivated by greed) and then backwards in waves of pessimism (at times panic motivated by fear), they are driven by the unconscious herding impulse. This produces a pattern that is largely predictable. Hence we can know in advance which way the herd is going to jump next!
Five steps forward, Three steps back...
For some reason (I won't go into the reason here) any change in public sentiment (mood) appears to be reflected first in the share market. Other financial markets appear to follow later. Changes in the economy come later still. (That's when economists finally pick them up).
Even economists and other "experts" acknowledge that the share market is "six to twelve months ahead of the economy." Their "explanation' for this is that the market has "factored in" known changes in the pipeline and so build a premium or discount into share prices in advance. Little do they realize that the clue to being able to predict financial markets and the economy far more accurately is staring them in the face. All they can do is build econometric "models" which extrapolate current and past data into the future and base their forecast on that information. This takes no account of anticipated changes in the mood of the public. Yet remember what even Bernard Baruch said:
"All economic movements, by their very nature, are motivated by crowd psychology, which has the power to unexpectedly affect any static condition or so called normal trend."
So a study of financial markets, with a view to being able to make forecasts, should be a study of crowd psychology, not economic fundamentals or "events" in the "news." Remarkably, human crowd psychology (behavior) has a pattern to it. If we could but crack that pattern, we could know where markets are going tomorrow, next month, next year, next decade.
We can!
The most basic pattern in the Wave Principle (named after accountant Ralph Nelson Ellliott, who "discovered" it in the 1930s) is a five-wave "impulse" followed by a three-wave "correction."
Whether you are looking at a 30 minute trading session on the stock exchange or a chart for the last 100 years for that same bourse, you will see the same pattern. It is not as precise as the tides or phases of the moon, but it is just as reliable and unmistakable. Because it is never a "perfect" pattern, it is called a "robust fractal." No two trees are identical in shape, size, colour or structure, yet you are unlikely to ever mistake a tree for an elephant or a bicycle. It is clearly a tree, even if it differs from the next tree in many respects. Similarly the form (shape) of Elliott "waves" is unmistakable, despite infinite variations.
As I said, that is the most basic pattern. Unfortunately it is not quite as simple as that. There are a dozen or so patterns that can unfold, and it takes some time to master them. But once you do, as I said, it is like discovering for the first time in your life that the earth is round.
And as I also said, there are "waves within waves." We refer to waves of varying degree (size). If you look at a chart for yesterday on the Dow, you will probably see that pattern. You may see it a number of times. If you look at a chart for the last month, you will probably be able to pick out the same pattern. In fact, if you look at a chart for the last 75 years, you will see that pattern:
- End of wave 1 - 1937
- End of wave 2 - 1942
- End of wave 3 - 1966
- End of wave 4 - 1974
- End of wave 5 - 2007
Does that give you a clue ? Can you see what is due next? Do you think I am surprised by the current weakness in the share market?
In my monthly online investment mentoring program and weekly updates I monitor the wave pattern in order to provide both a short and long term perspective on markets for stocks, real estate, gold, oil, currencies, etc.
Happy wave watching
Graham Dyer
