 How To Recognize
a Financial Mania
When You're Smack Dab in the Middle
of One
Susan C. Walker
Elliott
Wave International
Nov 13, 2007
When you're caught in the middle
of a bad storm, you don't really care whether it's a tropical
depression or a full-strength hurricane. You just know you're
hanging on for dear life. The same idea applies to financial
markets. When a market is trending up strongly, it's hard to
tell whether it's just a bull market or a more dangerous financial
mania.
The recent tremendous ride
up for global and U.S. financial markets, including the Dow,
looks and feels more like a mania than a mere bull, says Elliott
Wave International analyst Peter Kendall. This distinction is
important to recognize in the rising stage, because manias always
result in a crash that takes them back beneath their starting
point.
Kendall recently published
his research into current financial manias throughout the world
in SFO (Stocks, Futures and Options) magazine. The article,
titled "Financial
Manias and the Trade of a Lifetime," suggests an even
more stunning finish for the current manias: "The speed
and global scope of the unfolding credit crisis suggest that
most of the fast-rising markets of the last decade will crash
in unison," he writes.
As co-editor of The Elliott
Wave Financial Forecast, Kendall searches for trends that
help traders to move in and out of markets. By comparing other
historic manias with the impressive rise of the DJIA since the
late 1970s, he focuses on the skyscraper pattern that they all
have in common. The four historical manias are the Dutch Tulip
mania of the 1630s, the South Sea bubble of 1720, the U.S. stock
crash of 1921-1932 and the dot.com bust of the 1990s and early
2000s. Once you can see the similarities, you will be better
prepared to face the music when the crash comes. As Kendall writes,
"once the belief that the markets will always rise becomes
widespread, it actually signals the start of a price swing that
tends to be a career-breaker for any trader who tries to oppose
it."
He also discusses current manias,
such as the Nikkei, which has yet to return to its start after
a manic rise to its all-time high in December 1989, and the Dow,
which reversed from its rise in 2000 but made a U-turn in 2002.
The starting point for the Dow's mania as shown in the chart
included in the article is at the 1000 level.
Kendall, who is also writing
a book about financial manias, titled The Mania Chronicles,
describes five telltale signs that help an investor to tell the
difference between a regular bull market and a mania. It's a
mania if:
1. There is no upside resistance,
and rising prices seem to be perpetual.
2. Everyone in the market looks like an expert.
3. There is a flight from quality investments to riskier investments.
4. As financial bubbles pop in one area, they bubble up in others.
5. The crash after the peak takes back all the gains the mania
made.
No. 5 can be viewed only with
hindsight. But the first four signs provide essential clues to
what's shaping up in the markets.
"By studying past mania
experiences, traders can gain valuable insight into the collective
emotions that drive their markets," writes Kendall. "It's
possible to make significant money in the advancing stages of
a mania with no knowledge of its existence. But there is nothing
like recognizing a mania for what it is in real time to help
a trader keep those gains and deal with the relentless crash
after it peaks."
In the last part of the SFO
article, he asks the key question, Are we at the peak yet? Find
out his answer by reading
the whole article for yourself.
Susan C. Walker
Susan C.
Walker
writes for Elliott
Wave International a market forecasting and technical analysis
company. She
has been an associate editor with Inc. magazine, a newspaper
writer and editor, an investor relations executive and a speechwriter
for the Federal Reserve Bank of Atlanta.
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