We are often directed to think that the market reacts in the same manner as Newtonian physics. We believe that a news event which accompanies a market move was certainly the “cause” of that market move. But, how often have we seen markets react in the exact opposite manner in which the substance of the news event suggests?
While science has moved away from Newtonian physics, stock market analysts have not.
Wednesday, we saw a perfect example of this conundrum.
For most of the day on Wednesday, the media was warning us about the disastrous effects that a failed Brexit vote would have on markets around the world. We were told all day about how devastating the impact of a failed vote would be on financial systems that need stability. And, when the vote failed, market participants around the world held their collective breaths and braced for the worst.
Yet, the market has rallied 30 points (as of my writing this update) after this supposedly “devastating” occurrence the prior day. How is this possible?
In August 1998, the Atlanta Journal-Constitution published an article by Tom Walker, who conducted his own study of 42 years’ worth of “surprise” news events and the stock market’s corresponding reactions. His conclusion, which will be surprising to most, was that it was exceptionally difficult to identify a connection between market trading and dramatic surprise news. Based upon Walker’s study and conclusions, even if you had the news beforehand, you would still not be able to determine the direction of the market only based upon such news.
Until the times of R.N. Elliott, the world applied the Newtonian laws of physics as the analysis tool for the stock markets. Basically, these laws provide that movement in the universe is caused by outside forces. Newton formulated these laws of external causality into his three laws of motion: 1 – a body at rest remains at rest unless acted upon by an external force; 2 – a body in motion remains in motion in a straight line unless acted upon by an external force; and 3 – for every action, there is an equal and opposite reaction.
However, as Einstein stated: “During the second half of the nineteenth century new and revolutionary ideas were introduced into physics; they opened the way to a new philosophical view, differing from the mechanical one.”
Yet, even though physics has moved away from the Newtonian viewpoint, financial market analysis has not.
R.N. Elliott presented this perspective quite well back in 1946:
Many services and financial commentators in newspapers persist in discussing current events as causes of advances and declines. They have available the daily news and market behavior. It is therefore a simple matter to fit one to the other. When news is absent and the market fluctuates, they say its behavior is “technical.”
Every now and then, some important event occurs. If London declines and New York advances, or vice versa, the commentators are befuddled. Mr. Bernard Baruch recently said that prosperity will be with us for several years “regardless of what is done or not done.” Think that over.
In the dark ages, the world was supposed to be flat. We persist in perpetuating similar delusions.
– R. N. Elliott, Natures Law, 1946
Now, most of you will likely shrug this off and simply move on to the next event which is supposedly going to move the market. And, when you see an event which triggers a market move that is in line with the substance of the news event, all will return to normal in your prior world perspective. But, maintaining such blinders will potentially hurt your account at the absolute worst times.
Just something for you to consider.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.