Market Crowd Factor: Why Trend Might Not Be Your Friend Sometimes

“An advertisement said, 'Send me $1 and I will let you know how it was easy for me to become a millionaire.'
A man who wants to be a millionaire sent $1 in an envelop.
After a while he received a reply: 'I became a millionaire by asking to send me $1'
The next day, the advertisement said, 'Send me $1 and I will let you know how it was easy for me to become a billionaire.'”
- Author unknown

An advanced and robust principle, idea, or system might help to win in the stock market. But what if it is used by almost all market participants? Would everyone be a winner? Read to find out about cases when stock investing can be successful or risky.

Although a successful stock market investing or trading is complicated, in general, it consists of three major parts: analyzing data and possible future, making decision, and executing this decision. The same applies in case of automated trading - just these parts incorporated in the system and work in the same way. If we abstract from non-controllable external factors, we could clearly see that the quality of our decision and consequently the outcome depend on input data and their processing to make an optimal decision. What input data are the best and how to convert them into a meaningful information and finally into a right action?

Quality vs. quantity. First of all, apparently, too many data, especially, that are non-relevant to the searching result, might make the solution too noisy and with error ranges that exceed the accuracy of a certain solution. That is why most market participants use a limited but sufficient enough the set of input data in order to transform it further into a necessary information with a minimal uncertainty. The second important task is a processing with the highest quality of extracting worthy information. A good processing enables enriching the information while trying to avoid losing any value in the translation process.

Sometimes trend might be your friend. Is it possible to find and use the best universal principles and systems in stock trading? The second question - is it possible to make money using methods, systems, or ideas that are employed by many? It seems collective actions can be beneficial. For instance, if there is a uptrend - many would join the movement and add more pushing power up. Although a crowd behavior could be useful, sometimes, it can lead to unexpected results.

What if everyone does the same. Typical example - many thought that February could be a good month to invest because institutional funds' managers could increase their portfolios in March. Many converted cash into stocks in February pushing market up. Then when buying power exhausted and funds were unable to support this trend - the stock market collapsed. Another examples, several years ago October was a low month but since too many talked about this annual cycle, it is not the case anymore - everybody buys in October and pushes the market higher.

One more danger of crowd. Some classical books warn investors - when everyone is very bullish in the stock market - this is time when the market can crush because there is no one left who can invest more money to support the uptrend. It was in case of a hi-tech bubble in 2000. What factors influence our investing or trading decision? The opinion of most market participants? But their opinions link to their actions - that is why a trend might be built on sands and it can let you down anytime.

The benefit of using a new or rare approach. Let's imagine the situation - a group of people read the same book, for example, "How to Find Mushrooms" and all go to one forest. Evidently, then there would be more chances to find mushrooms in the places that are not recommended in this book. The conclusion - stock trading can be successful also in case of using something new or something that is used by limited number of traders.

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The Chain of Unfortunate Events Struck the Stock Market

The first hit on a weak global economy recovery was the re-appearing of European debt problems. Then as it turned out after revised estimate of the fourth quarter, the US economy grew 2.8% instead of 2.9% during 2010. Next, the uprisings in the Middle East induced oil prices to surge. A soaring oil price caused the fear of inflation. The market reaction to oil price overshadowed the good news of US improving labor market.

China normally has a trade surplus with the world but this time it reported a significant trade deficit for February. Higher prices for oil and other commodities increased its imports and decreased exports, raising concerns about Chinese inflation and growth. All above was enough to scare the bull but even more was set to come.

The natural disaster in Japan added a big portion of negativity to the stock market. Now investors are so concerned by a fragile global economy. Disrupting global supply and the estimates of an infrastructure damage show that the losses are disturbing. Evidently, this disaster is going to bring huge economical consequences to a global economy.

Worries might continue to dominate the market for a while. However, no matter what happens, fear always exceeds a possible realistic impact of any event. Hopefully, Japan's catastrophe will be the last one in the series of bad events of this year. To a natural law of harmonic balance, April, as a corporate reporting month, might bring some good news to the stock market. By the way, US job market is gradually healing - the unemployment rate is the lowest since April 2009.

Typical 10 Phases of Stock Market Disturbance

Within bear or bull market there are always fluctuations in stocks prices. It can be said about indexes, ETFs, and most other investing instruments. As example, let's consider an equilibrium market state that is based on a realistic evaluation. Assume it is a starting point. Then at some moment a good news released with the expectation that is above a realistic evaluation. The first reaction would be a price up-move (stage 1).



As prices are tend to rise, many would follow a simple strategy to join a growth movement that additionally enforced by greed (stage 2). Since there are always some participants in the market that might got this news with a delay or are too big to make the decision and perform transactions fast, the curve price might continue rising but with a slight less slope (stage 3). Normally, news can be accompanied by other overly optimistic opinions. Also there is always a room for some errors and miscalculations. These factors can be materialized in a short spike of prices (stage 4).

At some point, when a buying power exhausted and there are no other factors to sustain the growth, a reversal happens. All fast trading systems and dynamic participants of the market including short-sellers push the market down rapidly (stage 5). When the correction technically becomes more obvious, many start selling; the movement becomes stronger additionally enforced by fear and leads prices below the equilibrium line (stage 6).

Since fear is more strong drive than greed, normally the value of downtrend gradient is bigger than uptrend one. Two phases that are similar to ones existing in the uptrend curve part, delay (7) and miscalculation (8), follow until a bounce back (9). The after-bounce curve part can have a decaying-fluctuation pattern (stage 10). This pattern finally approaches the market evaluation to the equilibrium line.


Practically, very often, all described above consequent 10 phases might not be observed clearly due to several reasons. One of them is a fact that a single isolated news happens very seldom. Another typical reason is that all factors that drive the market might not be available in the form of publicly available information all the time.

© Alex Shmatov. Published with permission of the copyright owner. Further reproduction prohibited without permission.

2010 Stock Market Strength Might Propagate Into 2011

S&P-500 index has grown 12.78% during 2010 and it is ending on a positive note. The US corporate profits continue improving and companies have a lot of cash that provide opportunities for business optimization, better dividends, and make stocks more attractive. Also during the last several months the stock market became more predictable from the technical analysis point of view.

Many experts believe that the corporate earnings will grow further in 2011. Evidently, the prices of most shares will move in a natural cyclical manner with dynamical responds to unexpected news, as it was before. In average, major indexes are expected to perform around the same as in 2010. Anything can happen but, as always, extremes have less probability than averages.

Wishing You

Hopefully, 2011 will be a better year with many new opportunities for stock investors and traders!

November 2010: The Stock Market Is Taking Break

The US stock market reached the highest level in two years after a strong two-month rally. However, good news about improving retail results and a four-month low jobless claims rate were unable to push the market higher. Since the current market is driven mostly by news, it was a relatively rare case when technical indicators were able to predict a downtrend. A massive insider selling was another factor that contributed to the decline. If the correction is deep, then a consequent cyclical reaction might send the market up again.

The GDP grew at a 2% pace in the third quarter that is slightly better than the 1.7% growth during the second quarter. The government says that the improvement of GDP-to-deficit ratio is the biggest since fiscal 1987 year. Many analysts expect that the US corporate earnings will aspire higher despite a weakening dollar and a slow-speed recovery will lead eventually to an economic normalization.

SP-500 Index: the First Two Weeks of November 2010

Although technically there are no many signals for significant advance in any direction, a possible scenario could be a downside move at the end of the first week and then a slight bounce back. As example of technical prediction, see the chart. The chart has been plotted using InvAn-4 pattern recognition forecast for S&P-500 index prices (November 1-12, 2010).

From the summarized point of view, stock market investors may not rely on technical predictions but rather react to the US congressional elections and the Federal Reserve economic stimulus plans. Therefore, news might be a major driving force in the stock market for the first two weeks of November 2010.

October 2010 Stock Market Overview: Fundamentals Not Improving, Technicals Not Worsening

Due to a growing expectation that the US Federal Reserve will ease a credit environment to help the economy recovery, the US dollar dropped to several-month lows against most foreign currencies. More dollars may stimulate the economical growth. On the other hand, if the Federal Reserve pumps more dollars into the economy, a falling dollar can negatively affect consumers, businesses, and investors.

A dollar weakness together with the news that the US federal deficit for the 2010 budget year was estimated around $1.3 trillion add some fear of the instability of the system, Gold hit a new high that may also evidence a weak hope among investors for a decent stock market performance.

The US unemployment stayed at high 9.6% rate for the last couple of months. Adding jobless people who are not actively seeking work and people who are underemployed result more than 17%. Such statistics may indicate that the stimulus measures failed to create jobs as it was initially expected.

Some of technical indicators signal a lasting momentum that may keep the recent uptrend cycle for several weeks ahead. However, the third quarter earnings reports may not be so optimistic to sustain an existing stock market evaluation. In this case, major stock market indexes may have a correction if more negative news add the pressure.



The chart above shows S&P-500 forecast for the period from October 11 to October 22, 2010. The calculation has been performed using Neural Network Stock Trend Predictor NNSTP-2. The forecast is a slight uptrend.