Predict the Stock Market’s Direction

The term “prediction” can conjure up a lot of hocus pocus with images of crystal balls, tarot cards, and wizards, but when it comes to predicting the stock market, it has nothing to do with the fantastic and mystical, rather it is about the science of quantifying herd behavior in financial markets.

That behavior is easy to see when you watch stocks like Apple Computer explode upward on substantial volume as they report record growth through sales on products like their iPod and iPhone each quarter. But did you also notice what happened to the stock just after October 2007, when broader markets began to crash? The stock fell from a nearly $200 precipice, to nearly half its value in just two months!

What happened, did Apple’s amazing products suddenly fail to deliver, were consumers abandoning those products in favor of some other new fad device? Not at all! What happened to them is what happens to the best of companies in bear markets, they were sold, plain and simple. It’s the herd effect, the “get me out now!” mentality.

But it wasn’t just AAPL. It happened to GOOG too, and to RIMM, HP, GE, AA, and about 90% of all stocks across the board, with many also seeing their price halved in just a few short months!

That’s the extreme of financial herding, but was quite predicted by several indicators I like to watch – such as the $NYHILO – which measure the number of new highs against the number of new lows being created. That ratio peaked in July 2007 and had been rolling over for several months prior to the precipitous drop that occurred by year’s end.

But something I consider even more remarkable is the fact that there are other regular movements in the market that are also attributable to that same herding behavior, but these occur on a more regular, less dramatic, and still very tradeable basis.