If you really think about it, the stock market closely resembles a living, breathing entity.

It’s like an organism composed of millions and millions of cells, where each cell is an entity, a person, or an institution that makes investment and trading decisions.

While individuals make buy and sell decisions, the pulse of the market and the general movement of the market, one way or another, is often driven by the collective psychology of the organism.

If you understand how the collective psychology that’s moving the market works, you can be exactly where you need to be, almost all the time, and reap extraordinary profits in up and down markets.

Here’s how to read what the market’s saying, and how I recommend playing the current state of mind of the market…

The Trend is Your Friend

Never forget, the trend is your friend.

When you trade and invest based on the trend – meaning you play stocks from the “long” side (the buy side) when the trend of the general market is solidly up, and you play from the “short” side (sell and go short or buy put options) when the market’s trending down – you’ll find it’s hard not to make money.

Take the current state of the market; we’ve been enjoying an extraordinary – make that historic – bull market since 2009. The trend has been solidly up.

There are lots of reasons you and analysts can come up with as to why the trend has been up, but it’s not those reasons that reinforce each of the individual metrics that we look at and say, that’s a positive for stocks, that defines the trend; it’s the broad, collective psychology of market participants.

Investors, traders, and analysts don’t all look at the same metrics, and even when they do, they don’t all interpret them the same way. But the trend is irrefutable; it’s the one metric that matters, always.

The trend only changes when the collective psychology changes. Those changes can be for some short duration, or they can be huge changes that last for years.

Back to the Future

The trend’s been up, but the question is, as it always should be, will the trend continue? To answer that, always ask, in the broadest sense, what’s the general psychology about the market?

That’s easy to answer. First, what’s current trend?

Clearly, it’s up. Forget about daily or weekly market action. That’s just the market inhaling and exhaling. It’s going to fluctuate. Look at graphs of the market over longer timeframes, like quarters and years. It’s been up. So, basic psychology is bullish based on the trend.

Second, what’s the prevailing psychology as to why the market’s been going up?

Here’s where you look at a handful of metrics.

• How’s the economy doing, and what are its prospects going forward?
• What are corporate earnings doing?
• What kind of stocks are leading, and does it make sense that they’re doing what they’re doing?
• What’s the bond market doing, meaning interest rates, and how’s the stock market reacting to interest rate movements?

Really, that’s all you need to look at to figure out whether the current trend is intact. If most of your metrics support the trend, go with it and keep going with it.

When I look at the economy, to ascertain if the economy’s growing or slowing, I look at what the gross domestic product (GDP) numbers are and have been, and I look to see how consumers are faring and what their psychology is.

If consumers are “healthy,” that will reflect itself in the GDP numbers. That’s because consumer spending, which accounts for 2/3 of GDP drives production, revenue and corporate profits, which drives stock prices. GDP’s been trending higher. Consumers are in good shape and probably getting into better shape, and they’re in a great mood.

The most recent University of Michigan Consumer Sentiment Index for September came out at 100.8. That’s up from 96.2 in August, and it’s been trending up.

The Conference Board’s Consumer Confidence Index (CCI) came in at 138.4 in September, up from 134.7 in August, and has been trending higher, too. As a reference, the average CCI from 1952 through the end of 2017 was 83.39.

You can’t look at GDP and the economy and not look at unemployment and wages. Both have been positive, and both look like they’re going to continue to be positive drivers.

We’re hovering just around 4% unemployment and have edged below that low “natural rate.” With unemployment low, wages are starting to tick up. More money in consumers’ hands is a huge positive.

Like Calling the Grand Canyon a Ditch

The economic picture and mindset of consumers is a huge psychological boost for stocks.

To say that corporate earnings have been trending up is like calling the Grand Canyon a ditch.

Over the past seven consecutive quarters, corporate earnings growth has averaged 22.2% growth per quarter. That’s staggeringly good. Over the previous seven consecutive quarters, earnings growth per quarter averaged minus 9% per quarter. Strong earnings growth is a huge psychological positive.

The stocks leading the market higher are the ones that should be. For instance, tech stocks – with millions (and in some cases billions) of average daily users, members, and subscribers and with exponentially growing revenues and net profits – are leading the markets higher, and that makes sense.

There are no hyped-up, unprofitable stocks with fanciful dreams of making money leading the market. There are no groups of sham stocks leading the market. The psychology is positive because the leadership stocks are all running on increasing earnings and profits.

As for the bond market, it’s been doing a lot of nothing. The Fed’s hiking interest rates, but up until Thursday this week, stocks haven’t reacted to the known path of higher rates.

Any hiccups in the stock market aren’t unexpected, especially with the 10-year Treasury yield suddenly spiking.

What’s important is to see how stocks react to the 10-year getting to 3.25%, a psychologically important level. If the stock market sees the 10-year there, and, after convulsing, gets back on an upward trend, that’s the psychology of the organism telling us that it’s okay and that higher rates are more a sign of a growing economy than some other dislocation somewhere.

When it comes to the Fed, they’re not going to risk upending the stock market by raising rates too fast or too often. So, the psychology should be positive in terms of manageable interest rate moves.

That’s how I gauge the psychology and current state of mind of the market’s participants and the market. It’s positive. And that means keep playing from the long side. If the mind set changes, I’ll be the first one yelling to you to look at what’s changed.

The market isn’t a mystery. All you have to do is listen and understand what it’s saying.