This article appeared in the June 2014 ASX Investor Update email newsletter. To subscribe to this newsletter please register with the MyASX section or visit the About MyASX page for past editions and more details.
By Dale Gillham, Wealth Within
In general conversations about the sharemarket, most people believe market movements are caused by news or political events. But I suggest it is the social mood, or the general mood of a society, that actually determines the market's direction.
The entrenched belief that the daily news moves the market has been reinforced for so long that when I am teaching people to trade the markets, many struggle to accept that the opposite could be true because they are so used to reacting to the news - and as a result are not trading profitably.
I suggest that whether you are a trader or an investor, if you learn to read what is happening with the social mood in any market, you will see what most do not and be able to build the wealth most want.
What is social mood?
In simple terms, the social mood is really about confidence, or how confident we are as a society about our future. The more confident our underlying mood is, the more likely we are to invest. The more pessimistic we are, the more we stay away from the sharemarket and investing in general.
Understanding the collective mood is so much simpler than trying to keep up with all of the latest in world economics and news events, and, more importantly, trying to understand the effect that might have on your investments. It will also ensure that you are better prepared for the most important moves any market makes.
Experts on social mood say that a major market index is to social mood what a barometer is to weather. A barometer measures changes in air pressure to indicate a change in weather. Imagine if you were able to read the market's future that way. You can, by using a price chart.
Social mood is not a study of short-term emotion, but rather medium-to-long-term trends in thinking and behaviour. To look at social moods in the short term would be just as futile as looking at the daily price action on the sharemarket. Professionals know that daily fluctuations are irrelevant, but many amateur traders analyse the market that way. In doing so, they miss the bigger picture, in other words the trend, which makes them far less effective traders.
Accompanying price charts for a number of markets show the trend and how the masses are moving from being optimistic to pessimistic, or in reverse. If the overall trend is rising, the underlying mood is optimistic, or bullish. If the trend is falling, the mood is pessimistic, or bearish.
The role of social confidence
It is the underlying social confidence of a market that determines direction, not short-term emotions. Mistakenly, so many people look at the evening news to make decisions about what is going on in the market.
A great example of how the social mood works was when the US Federal Reserve announced that the quantitative easing program (a form of monetary policy) would eventually be tapered. Initially the market reacted swiftly with a sell-off. But the social mood in America at the time was more optimistic about the future and so the market quickly recovered. Each time the Fed met, it continued to test the market and at first it reacted negatively, only to recover.
There is a point in any trend when the social mood becomes over optimistic or over pessimistic about market tops and bottoms, and this is when the social mood signals a likely change in market trend. Sadly, the masses tend to miss the signals and get caught out as the market starts to do the opposite to what they expected. Being aware of social mood without getting swept up in the mindset of the herd is a very valuable skill. The easiest way to gain this is to learn to read a price chart.
Reading a chart is all about reading the trend, as we can easily see if the trend is rising or falling, which is what I will share with you in regards to some of the major world markets.
Although I do not regularly follow the mood of all international markets, I will show how, by looking at a longer-term chart of these markets, you can gauge the overall social mood. I will use some technical analysis techniques to assist in determining how these markets are likely to unfold in the future.
S&P 500 Stock Index (SPY)
Looking at a monthly chart of the S&P 500 Stock Index we can see that the mood in the US is currently strongly up. In May 2013 the market broke out of a long-term sideways move, or pattern, into blue sky. This means the trend is likely to continue in the longer term, but whenever there is a breakout from this type of formation, there is a chance that the price can swing back to the pattern before the longer-term trend continues.
We need to watch how the market behaves around 1900 and 2100 points, as this is where we could see signs of a change in the current mood. What we may see as an indication of a change in mood is that the price starts rising at a slower pace.
Shanghai Composite (SSEC)
Looking at the Shanghai Composite, it is easy to get a feel for the mood in China, and it is largely negative. As a result, the market is down. You can see more recently that from around February 2013 the trend has changed to more sideways and if the social mood fails to change to being more optimistic, the SSEC will struggle to get back above 2300 points anytime soon.
Without a rise above this level, this market is likely to continue down to test strong support at around 1700 points. Professional traders will be watching for an indication of a potential change in the trend at these levels, while considering the risk of a further fall to between 1300 and 1700 points.
All Ordinaries Index (XAO)
The mood of the Australian market has generally been up for the past couple of years, although you would not say it has really made a move to being over optimistic. Since October/November 2013, our market has essentially been trading sideways and the chart shows that the rise stopped at around 61.8 per cent (5413 points) of the distance it fell from the all-time high to the low in 2009. That means the market still has some way to break to a new record high.
At the moment, the social mood in Australia seems to be in a state of flux, with indecision and/or inaction from investors. We have not seen the sorts of volatile moves one would expect at a major market top and provided the All Ordinaries remains above 5100 points, the current trend is likely to continue to around 5800.
About the author
Dale Gillham is author of How to Beat the Managed Funds by 20%, and is Director/Chief Analyst of Wealth Within.
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