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The Wisdom of the Crowd - Understanding the Language of the Market

If you want to understand the language of the stock market then sit back and spend a few minutes watching this fascinating YouTube video titled 'The Wisdom of the Crowd'. You may not get the link between this video and stock market action immediately, but below I try to complete the circle for you.

Completing the Circle
Let me now relate the YouTube video's bean-counting experiment to the stock market; if market participants have a view of the future, they express it in the market by buying or selling. Many views are extreme, some very bearish, some very bullish and with most views somewhere in between. The actions of millions of people determine where the market goes.

Despite the extreme views (the outliers), the average view does a fairly good job of anticipating what lies ahead. For this reason, the stock market is the best leading indicator of the likely business conditions ahead. The market is not always right, of course, and therein lies the rub of it. We cannot know the future for sure, but the average guess is more accurate than any individual view, just as it was in the YouTube bean-counting experiment.

This is why you can largely ignore market forecasts about the future from individual commentators no matter how well informed they appear to be. What you need is in front of your eyes; the market itself is your best guide.

In my own book 3 Steps to Investment Success in Chapter 6, Understanding Stock Market Volatility, I outlined how, in March 2009, the average view suddenly changed from black bearish to anticipating recovery. At that time, if you were reading what was in the media, the universal view was supposedly apocalyptic. Yet, the market started a recovery.

Initially, the recovery was denounced by most commentators (including the economist Nouriel Roubini). But the market kept rising. It's not what people are saying that matters in the market. It's what they are doing, and in March 2009 the average investor was buying, not selling. Investors started buying in March 2009 because they saw recovery, and they saw it right because the real economy did indeed begin a recovery in late 2009.

You have to learn how to read the market to understand the difference. In that regard, the opening quote by Charles H. Dow (original editor of the Wall Street Journal), in the excellent book written by my colleague Jack Schannep Dow Theory for 21st Century, is one of the finest I have read and I quote directly from Mr. Schannep's book;

"A person watching the tide coming in and who wishes to know the exact spot which marks the high tide, sets a stick in the sand at the points reached by the incoming waves until the stick reaches a position where the waves do not come up to it, and finally recede enough to show that the tide has turned. This method holds good in watching and determining the flood tide of the stock market"

Dow Theory for the 21st Century is not an infallible technical indicator, but it is a common sense approach and relies on the average view for guidance, and not the views of any particular individual. As a technical indicator, it has one of the very best market timing records on the US stock market.

Of course, understanding the language of the markets is not necessary if you simply want to buy good value assets, which is the principal aim of the GillenMarkets website. Nonetheless, it is fascinating to know what the market, or average view, is saying at any point in time!


Rory Gillen