Please Don't Shoot The Messenger, But You Still Need To Understand This Message

While many still hold fast to the old paradigm that fundamentals or news drive sentiment, I am constantly being asked if news does not drive sentiment, then what does?

What do the recent studies prove?

Social experiments have actually been conducted which resulted in price patterns that mirror those found in the stock market. In 1997, the Europhysics Letters published a study conducted by Caldarelli, Marsili and Zhang, in which subjects simulated trading currencies, however, there were no exogenous factors that were involved in potentially affecting the trading pattern. Their specific goal was to observe financial market psychology "in the absence of external factors."

One of the noted findings was that the trading behavior of the participants were "very similar to that observed in the real economy," wherein the price distributions were based on Phi (.618).

Their ultimate conclusion would surprise the most avid trader today:

In spite of the simplicity of our model and of the strategies of the single participants, and the outright exclusion of economic external factors, we find a market which behaves surprisingly realistically. These results suggest that a stock market can be considered as a self-organized critical system: The system reaches dynamically an equilibrium state characterized by fluctuations of any size, without the need of any parameter fine tuning or external driving.

Marsili was quoted as saying that "the understanding that we got is that the statistics of price histories in financial markets can be understood as the result of internal interaction and not the fundamental interaction with the external world."

What this study proves is that one does not need exogenous causation to direct a market to act as financial markets normally do. So, even if you add in exogenous factors into the study, the results would remain the same. The reason I can confidently state this is because of other studies which support the fact that exogenous events, such as surprise news, have shown to have no effect upon the stock market.

In a 1988 study conducted by Cutler, Poterba, and Summers entitled "What Moves Stock Prices," they reviewed stock market price action after major economic or other type of news (including major political events) in order to develop a model through which one would be able to predict market moves RETROSPECTIVELY. Yes, you heard me right. They were not even at the stage yet of developing a prospective prediction model.

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Avi Gilburt is a widely followed Elliott Wave technical analyst and author of ElliottWaveTrader.net ( more

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