I have been asked a number of times, in the comments section of my articles over the last few months, about how I am able to track market sentiment. I know I have only alluded to how I track sentiment, but it is simply because the methodology I use is quite esoteric and mathematically based, and one in which the great majority of the market does not believe. But, since so many of you have asked, I will try to explain it from a broader fundamental perspective.
As I have mentioned many times before, Mr. Alan Greenspan, former Chairman of The Federal Reserve, noted that markets are driven by "human psychology" and "waves of optimism and pessimism." Ultimately, as Mr. Greenspan correctly recognized, it is social mood that will move markets. This is why news does not cause a change in the trend of the market, unless that trend is already set to change. In fact, have you ever wondered why a market will continue to go up after the announcement of bad news, or down after the announcement of good news? Have you ever wondered why the seemingly same announcement by the Fed over the last two years has supposedly caused the metals to rally at times, while at others collapse?
This is why any investor who is able to rise above news and emotion, and identify the prevailing social moods and trends, will have a significant advantage over other investor.
Back in the 30's, Ralph Nelson Elliott postulated that public sentiment and mass psychology move in 5 waves within a primary trend, and 3 waves in a counter-trend. Once a 5 wave move in public sentiment is completed, then it is time for the subconscious sentiment of the public to shift in the opposite direction, which is simply a natural cause of events in the human psyche, and not the operative effect from some form of "news."
This mass form of progression and regression seems to be hard wired deep within the psyche all living creatures. This is what we have come to know today as the "herding principle," and the herd seems to turn at Fibonacci ratios, as supported by many various studies.
Humans are hard wired for herding within their basal ganglia and limbic system within their brain, which is a biological response they share with all animals. In fact, in a study performed by Dr. Joseph Ledoux, a psychologist at the Center for Neural Science at NYU, he noted that emotion and the reaction caused by such emotion occurs independent and prior to, the ability of the brain to reason.
In a paper entitled "Large Financial Crashes," published in 1997 in Physica A., a publication of the European Physical Society, the authors, within their conclusions, present a nice summation for the overall herding phenomena within financial markets:
Stock markets are fascinating structures with analogies to what is arguably the most complex dynamical system found in natural sciences, i.e., the human mind. Instead of the usual interpretation of the Efficient Market Hypothesis in which traders extract and incorporate consciously (by their action) all information contained in market prices, we propose that the market as a whole can exhibit an "emergent" behavior not shared by any of its constituents. In other words, we have in mind the process of the emergence of intelligent behavior at a macroscopic scale that individuals at the microscopic scales have no idea of. This process has been discussed in biology for instance in the animal populations such as ant colonies or in connection with the emergence of consciousness.
In fact, one commenter to one of my articles on Seeking Alpha made the following astute point regarding how news affects these subconscious herding trends:
Compare the market to a stream of ants marching by in, generally, a single direction. Run a stick across their path and there will be some momentary confusion and reaction to the direct stimuli but very soon afterwards the original parade of ants continues and the stimulus is forgotten.
So, based upon much research, it does seem that the market may be considered to be on a path that is determined by a mass form of herding that is given direction by social mood. It sure does explain the oft asked question of why markets go up when bad news is announced or vice versa. It also takes out all the guess work in attempting to determine the next "news event" that may move markets. This is why you never hear me referencing news and what it will supposedly do to a market. If you want to track news and its supposed effect upon the metals, there are hundreds of authors that you can chose to read, but, they have been horribly and consistently whipsawed these last two years.
The question then comes up as to why I can be so accurate about market turns so often, and, sometimes, be wrong. Well, as we know, there simply is no holy grail to markets, since they are non-linear beasts. Rather, we attempt to identify the framework within which we can trade such a variable system of movements. Along those lines, when the market is in a corrective state, it takes many twists and turns, especially since corrective action is the most variable of all market action.
This is why it is imperative to maintain an open mind during corrective market action and be extraordinarily nimble. It is for this reason that most market participants and analysts have been so badly whipsawed over the last two years since the market topped in 2011. In fact, there have been more calls for the bottom of the metals being in than the amount of hair I have left on my head. It is because most analysts do not understand the larger framework from within which the metals move. And, anyone who demands an "absolute" or states that the market "must" do something in particular is simply being foolish and setting themselves up for more whipsaw. This is exactly why it is rare to find a single analyst who has made consistently correct calls on the metals for the last two years.
We have been in a 2 year long corrective decline with many twists and turns. And, we are not yet done. So, when someone asks me for an absolute perspective on where and when the metals will go next, I am simply unable to provide you any amount of certainty within such a large corrective pattern that has taken over two years. While some of you may view that as a limitation of such a methodology, I must also point out that I still have not seen anyone more accurately identify more turning points in the metals over the course of the last two years. But, sometimes, we have to take it month by month within this type of market action until we finally reach our expected lows.
Back in early September, I explained to readers to "Prepare Now For Silver's Upcoming Decline." I fact, in my Trading Room at Elliottwavetrader.net, I was keying in on the 138 region in GLD and noted to my subscribers that I was shorting GLD at 138 with a target of 120-123GLD. I think we have all seen how well that trade has worked out. While I am still looking for much lower levels to be seen in the metals, for the last few weeks I had been questioning whether we would see it in October or November, or as late as 2014. And, as I said in my last article on Seeking Alpha, "if the 119/120 region is maintained as support, this can spark a rally back to the 129 region, and even take GLD all the way back to the low 140's. It is from this region we will likely short it once again for our lower targets cited above."
Well, as the market was coming down into our target support region, and displaying positive divergences on the charts we follow, along with hitting technical support on the MACD, it became more and more clear that the new lows were not going to be seen just yet, and the rally towards the 129 region was about to begin. In fact, the option's guru in our Trading Room, Xenia Taoubina, structured an options trade as we moved into the 120/121 region which allowed our members to hugely, and safely, profit on the rally we experienced over the last two weeks.
So, now the question is if we are going to be able to move through this initial target region, and attack the 140-145 region, or are we now set up to break down to new lows? Well, this is where being within the larger corrective pattern makes us need to be ready for either scenario, and be able to identify which one is playing out. Currently, I have Fibonacci resistance between 131.50-133 in GLD and 22.90-23.55 in silver futures. As long as the market maintains below these levels, and begins an "impulsive" decline rather than a "corrective" decline, then it is likely that we will be heading to new lows within weeks. However, if the market should decline "correctively" over the next week or so, it will likely take out that resistance region, and it becomes much more likely that we will see levels which will potentially exceed the September highs, which will then set up what should be the final decline to new lows before this 2 year correction completes in the metals.
While there are several market signs that have me leaning in one direction at this time, I think you have enough information here to be able to handle your metals' accounts over the next week or two. Either way, what is important to note is that the current region for the metals is point of inflection, and knowing what to do as you see the market develop is the most important tool you can have at your disposal.
But, keep in mind, it is much more likely than not that we have not yet seen the true bottom for those that are looking for silver to rally to $70+. We will likely see silver exceed $70, but not before the bottom has been made. Yet, as I have said countless times to my subscribers, those that have a very long term perspective in silver should view drops below $20 as opportunities to add to long term positions, especially if I am wrong about the low not yet being in.
Disclosure: I am long SLV, GLD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I also have intermediate term puts