Typically, unsophisticated investors tend to buy near tops and sell near bottoms… exactly the opposite of what they should be doing. And there is a very good psychological reason for this. They start out cautious and then as others begin making more and more money in the market the Fear of Missing Out (FOMO) takes over and eventually they get in to the market. They may make a little money and decide they are geniuses and commit more and more money. Eventually, everyone with available money has invested and there is no one left to buy so the market crashes. The unsophisticated investor holds on initially knowing the market will rebound as it “always” has. Then he holds on because he has “lost too much to get out now” and finally when he can’t stand it any longer he sells vowing never to invest again. This turns out to be the bottom, as there are no more people left to sell, and the market turns up. But “once burned, twice shy” so the unsophisticated investor once again refuses to buy until the market nears another top and “everyone is making money in the market”. ~Tim McMahon, editor
This Suggests That Stock Prices Are Headed Even Lower
History shows that investors become “long term buyers” at precisely the wrong time
By Elliott Wave International
It’s been mentioned before in these pages that the stock market is filled with paradox.
Examples include the observation that widespread denials of the existence of a bubble is an excellent indicator that one exists. Another is that bear markets tend to start when the news is good, and bull markets kick-off when the news is bad.
Here’s another paradox — one to keep in mind during the next bear market:
Numerous lows will be touted as the low, which will not occur until people stop calling for it.
That’s a quote from the February Elliott Wave Financial Forecast, a monthly publication that provides an analysis of major U.S. financial markets.
So, put another way, a sign that stock prices are likely headed even lower during a bear market is when market observers are still touting lows.
Now, let’s shift a little and look at typical behavior when downturns are just getting started. That’s when many investors believe that the drop in prices is merely a correction — which, as you know, is often mentioned as the classic “buying opportunity.”
Indeed, this is a headline from Feb. 7 (Business Insider):
Investors should prepare to buy the dip in stocks after the Fed’s first interest rate hike in March, BofA says (emphasis added)
The very next day (Feb. 8), the same news source had a somewhat similar headline (just a different financial institution and reason for “buying the dip”):
UBS tells investors to buy the dip in US stocks on the back of strong earnings and predicts the S&P 500 will rally 8% this year (emphasis added)
“Buy the dip” they did — as this Feb. 9 headline attests (CNBC):
… [I]nvestors continue to buy the January tech dip … (emphasis added)
Then, on Feb. 11, after the S&P 500 shed 3.7% in just two days, another well-known financial website sported this headline (Marketwatch):
Five reasons why you need to buy the dip in stocks [emphasis added]
And, let’s make room for yet one more (CNBC, Feb. 13):
Buy the dip on these global stocks with strong returns, Goldman says
“Buying the dip” is not just “modern-day” investor behavior — it’s been around a long time.
Here’s a quote from the 1917 book One-Way Pockets, written by a stockbroker who went by the pseudonym, Don Guyon:
“The public’s memory for former high prices usually proves to be more of a liability than an asset. The expectation that these high prices will again be reached causes them to buy many a dead speculative dog.”
In case you’re unfamiliar with One-Way Pockets, Elliott Wave International President Robert Prechter summarized the book in one of his Elliott Wave Theorists:
A stockbroker wondered why his clients lost money over a full cycle in the stock market. After all, he reasoned, if stocks were back near the same level they started, shouldn’t his clients have broken even? The pseudonymous Guyon studied his clients’ activity statements and found a consistent psychological change among them that explained the losses: At bottoms, they were short term buyers, whereas at tops, they were long term buyers. (emphasis added)
Understanding Elliott wave analysis can help keep investors from falling into this trap.
You see, the Elliott wave model anticipates trend changes.
Here’s what Elliott Wave Principle: Key to Market Behavior, by Frost & Prechter, says:
It is our practice to try to determine in advance where the next move will likely take the market. One advantage of setting a target is that it gives a sort of backdrop against which to monitor the market’s actual path. This way, you are alerted quickly when something is wrong and can shift your interpretation to a more appropriate one if the market does not do what you expect. The second advantage of choosing a target well in advance is that it prepares you psychologically for buying when others are selling out in despair, and selling when others are buying confidently in a euphoric environment.
Educate yourself about the Wave Principle by reading the entire online version of the book for free.
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This article was syndicated by Elliott Wave International and was originally published under the headline This Suggests That Stock Prices Are Headed Even Lower. EWI is the world’s largest market forecasting firm. Its staff of full-time analysts led by Chartered Market Technician Robert Prechter provides 24-hour-a-day market analysis to institutional and private investors around the world.
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