How financial markets deceive you
2023.01.24 05:11
How financial markets deceive you
Budrigannews.com – I believe it is important to begin this missive by reposting something that Robert Prechter wrote in The Socionomic Theory of Finance, which I strongly recommend to every investor, before we move into a review of the last few months of market action to learn what the majority of investors did wrong:
“The job of observers, in their view, is to simply determine which external events caused any price changes.” They believe there is a connection between news and market movements when they appear to coincide in a rational way.
They try to fit news into a cause-and-effect structure when it doesn’t fit. When they are unable to even come up with a plausible way to twist the news into a way that justifies market action, they blame “psychology” for the moves. This means that, despite having a lot of news and a lot of creative ways to interpret it, their imaginations aren’t big enough to come up with a plausible causal story.
News causality is easy for observers to accept most of the time. News and financial markets fluctuate frequently, and sometimes the two coincide sufficiently to reinforce commentators’ mental bias toward mechanical cause and effect.
They shrug and ignore the inconsistency when news and the market don’t match. In finance, people who operate under the mechanics paradigm never seem to notice or care that these obvious anomalies exist.”
We are about to see some real-world examples of how many of you have ignored some serious recent inconsistencies, so I sincerely hope you read that carefully. And the only way you will learn is to be able to pinpoint instances in which you may have been mistaken and explain why.
The report came in hotter than most anticipated on October 13. The market actually reached its bottom that day and ended up being positive by 2.6%, despite the widespread belief at the time that it would crash. In addition, it actually sparked a rally of 17.5% in response to that alleged poor report.
Since they were operating under the conventional mechanical cause-and-effect paradigm regarding how the market should respond to the news, it was evident that many people were perplexed by this at the time. One Seeking Alpha commenter noted:
“Am I the only one who is puzzled by the state of this market?” It no longer makes sense to me; today made absolutely no sense.”
In fact, the author of the Barron’s article later that day outlined the general market sentiment:
“It was a huge rally that happened out of nowhere. Additionally, it has left market observers like myself perplexed as to what exactly transpired. There was no new data, no speech that made the news, and no event that happened right after the opening that would have prompted such a move. It literally appeared out of nowhere, leaving us grasping for explanations. Oanda’s Edward Moya writes that “the market reversal of today was a head-scratcher.” And he is correct.”
However, you probably anticipated a significant bottoming if you did not view the market through the conventional mechanical cause-and-effect paradigm. In point of fact, this is what I wrote to our ElliottWaveTrader members just an afternoon before the CPI was released and we started that rally:
“The market has attempted to reach the blue box support region on the 60-minute SPX chart multiple times thus far.” Divergences continue to widen each time. As long as we remain below the smaller degree of resistance that has been noted, there is still an opportunity to actually strike that support below on the 5-minute SPX chart.
However, depending on how long it takes the market to bottom out and how quickly I anticipate the rally to take hold, I believe we will be significantly higher than where we are at the moment as we look out towards the end of October or even into early November.”
I also stated that I anticipate a rally to the 4100-4154 region following a near-term bottom:
Additionally, our members expressed their appreciation for the appropriate lens through which they could view the market:
“…today was like EW proof on steroids. Had an up 8% portfolio run – including selling shorts at the bottom and immediately loading up on the turn. Without this service I would never have been poised to jump that quick. The confidence of recent updates was pretty overwhelming.”
“Just want to say that was an amazing call this morning… I have been a member for about 8 months. Definitely an Elliot Wave neophyte, but lots of trading experience. just amazed. I be 62, old dawg. Great, great service.”
However, do you believe that any of the surprised individuals considered the possibility that they were working with the incorrect market paradigm? Nope. “[w]hen news and the market fail to coincide, they shrug and disregard the inconsistency,” as Mr. Prechter outlined above regarding the majority of market participants. The majority, I’m pretty sure, simply ignored this inconsistency and moved on to the next set of data they thought would move the market. Therefore, let’s move on to the next significant inconsistency.
I began preparing our members for a pullback as the market approached my expectation of the 4100-4154 SPX region target from the October 13 low. Additionally, we can now focus on yet another economic report that appears to be crucial.
The CPI report was released on December 13 and came in lower than anticipated. What did the market do then? That day, the market reached its peak and began a 8% pullback. Yes, that is correct. Even though the CPI report came in better than expected, it started a significant pullback. Do you think that’s what most people in the market thought would happen? No, no, no.
And, as one of my members commented that day:
“I mean, it takes a lot of mental gymnastics to make that square without EWT, bottoming on the worst inflation print and topping on the best.”
As a result, participants in the market who continued to adhere to the mechanical cause-and-effect model were once more caught on the wrong side of the move and left their heads scratching. However, do you believe that any of the surprised individuals considered the possibility that they were working with the incorrect market paradigm? Nope.
“[w]hen news and the market fail to coincide, they shrug and disregard the inconsistency,” as Mr. Prechter outlined above regarding the majority of market participants. The majority of them, I’m pretty sure, ignored this inconsistency once more and moved on to the next set of data they thought would move the market. Therefore, let’s move on to the subsequent set of crucial data.
A report that came out on January 18 was much better than expected, which suggested that inflation was getting under control. Naturally, then, the market must have surged, right? Nope. In fact, the market lost more than 1.5% on that day.
Even more fascinating is the fact that, on Thursday morning the following day, Bloomberg broadcast interviews with Fed members stating that the days of 75 basis point raises are over and that 25 basis point raises are now likely. Again, do you believe the market did well? Nope. That morning, the market just continued to fall.
Again, I want to know if you think any of the people who were taken aback considered the possibility that they were operating under the incorrect market paradigm.
Or did you, once more, ignore the inconsistency when the market and the news did not coincide? And at what point do we even begin to comprehend that the alleged inconsistency was the typical market reaction, despite the fact that it moved in opposition to expectations at the lows and highs over the past four months?
To put it another way, over the course of the last four months, the market appeared to ignore the substance of the news of the various most important economic reports three times, even though it reached its peak at the point where we anticipated it to do so. The conventional mechanical cause-and-effect market paradigm needs to be questioned. It is unquestionably ignored by the market.
Despite the fact that news and economic reports can act as a catalyst for a market move, the content of those reports is not always indicative of the direction of the move. This is something that I have repeatedly emphasized. In addition, the preceding four months have provided us with extremely stark examples. Therefore, if you have been attempting to predict market movements based on these reports, you have probably experienced numerous severe whipsaws. However, I can assure you that you are not alone; the majority of analysts and market participants have also been in your position.
Therefore, shouldn’t it be considered that the mechanical cause-and-effect paradigm is incorrect at this point? Isn’t it time to look into something else that can help you make more accurate predictions about these reports and the market as a whole?
Our initial resistance is located at 3990/4000 SPX. I anticipate another test of our support in the 3820-3885 SPX support region as long as we remain below that resistance. Furthermore, my primary expectation is that we will soon be developing a rally to 4300 or higher as long as we maintain that support.
Our upper resistance is 4041-4078 SPX if we experience an immediate breakout above 4000. To inform me that we are moving toward 4300+ even sooner and more directly than I currently anticipate, it would require a direct break through of that resistance.
Regarding a deeper pullback, an impulsive breakdown below 3820 SPX could lead to a fall into the 3600-3650 SPX region, from which the market could attempt a set-up rally to the 4300 SPX region in the coming months.
People who make comments like “so you are saying the market is either going to go up or down” always amaze me. Additionally, these individuals’ perspectives on the market are regrettably rather naive. The market, after all, operates in a nonlinear environment. In addition, we approach it in this manner in our analysis by employing appropriate risk management parameters. We are compelled to immediately adjust our positioning to our alternative perspective if the market breaks support within a pattern we are tracking, particularly if it does so impulsively. Once more, this is for risk management.
This is not dissimilar to what would happen if an army general developed both his primary battle plans and a backup plan in the event that his primary battle plans fail. Simply put, it’s how the general gets ready for battle. Similar preparations are made for market battles.
As a result, I hope I have adequately explained why the mechanical cause-and-effect paradigm, which is commonly used, frequently sets you up with unrealistic expectations. There has been ample evidence to support my premise in just the past four months alone. You are simply demonstrating Einstein’s definition of insanity by repeating the same action and expecting a different outcome if you continue to ignore the obvious inconsistencies presented by the mechanical cause-and-effect paradigm. Every rational individual ought to reevaluate the mechanical paradigm in light of the glaring and obvious anomalies that have been observed in just the past four months.
In addition, there is an improved approach to the market that will typically keep you on the right side of market movements. Additionally, it provides objective and early indications when it is incorrect, allowing you to adjust your positioning. It is most prudent, objective, and profitable to approach the nonlinear environment of our financial markets in this way.
