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Monday 20 April 2015

SPECIAL REPORT: #4 Patterns of STOCK #MARKET CRASHES

SPECIAL REPORT

This exclusive North American article will be broken into a series of five consecutive posts providing our readers with  useful market edges and insights that are unprecedented amoung peers, into the empirical patterns behind historical and "possibly future stock market crashes." The article is sourced and supported by the author's research; having first been published earlier in renowned European journals. Applying such knowledge wisely, thereby optimizes the chances for better decisions and increased wealth - First Financial Insights, Toronto, April 2015


New Stock Market Crash, A Pattern?

Part 4 -  Stock Index Graphs Are Fata Morganas.

What does a stock exchange index like DJIA, S&P 500 or AEX really mean?

The Dow Jones Industrial Average (DJIA) index is the oldest shares index in the United States. A select group of journalists of The Wall Street Journal decide which companies are included in the most influential stock exchange index in the world. Unlike most other indices the Dow is a price average index. This means that shares with a high price have a great influence on the movements of the index.
A History Lesson 




The S&P index is a market value index. This index, compiled by credit evaluator Standard & Poor’s, includes the 500 largest US companies, based on their market capitalization

The Amsterdam Exchange Index (AEX) is the most important stock exchange index in the Netherlands. It shows the development of share prices of the top 25 funds of the Amsterdam Stock Exchange, based on trading. The AEX is the average price of the shares of those funds.

In many graphs the y-axis is a fixed unit, such as kg, meter, liter or euro. In the graphs showing the stock exchange values, this also seems to be the case because the unit shows a number of points. However, this is far from true! An index point is not a fixed unit in time and does not have any historical significance.


An index is calculated on the basis of a set of shares. Every index has its own formula and the formula gives the number of points of the index. Unfortunately many people attach a lot of value to these graphs which are, however, very deceptive.

·        An index is calculated on the basis of a set of shares. Every index has its own formula and the formula results in the number of points of the index. However, this set of shares changes regularly. It is therefore very strange that different sets of shares are represented by the same unit.
After a period of 25 years the value of the original set of apples is compared to the value of a set of pears. At the moment only 6 of the original 30 companies that made up the set of shares of the Dow Jones at the start of the acceleration of the last revolution (in 1979) are still present.

Even more disturbing is the fact that with every change in the set of shares used to calculate the number of points, the formula also changes. This is done because the index which is the result of two different sets of shares at the moment the set is changed, must be the same for both sets at that point in time. The index graphs must be continuous lines. For example, the Dow Jones is calculated by adding the shares and dividing the result by a number. Because of changes in the set of shares and the splitting of shares the divider changes continuously. At the moment the divider is 0.132319125 but in 1985 this number was higher than 1. An index point in two periods of time is therefore calculated in different ways:

Dow 1985 = (x1 + x2 + ........+x30) / 1
Dow 2009 = (x1 + x2 + ........ + x30) / 0,132319125

In the nineties of  the last century many shares were split. To make sure the result of the calculation remained the same both the number of shares and the divider changed (which I think is wrong). An increase in share value of 1 dollar of the set of shares in 2009 results is 7.5 times more points than in 1985. The fact that in the 1990-ies many shares were split is probably the cause of the exponential growth of the Dow Jones index. At the moment the Dow is at 9665 points. If we used the 1985 formula it would be at 1279 points.

·        The most remarkable characteristic is of course the constantly changing set of shares. Generally speaking, the companies that are removed from the set are in a stabilization or degeneration phase. Companies in a take off phase or acceleration phase are added to the set. This greatly increases the chance that the index will rise rather than go down. This is obvious, especially when this is done during the acceleration phase of a transition.
This is actually a kind of pyramid scheme. All goes well as long as companies are added that are in their take off phase or acceleration phase. At the end of a transition there will be fewer companies in those phases.



<<Fig 3rd industrial revolution and the S&P 500  >>






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ABOUT ARTICLE 

The article “A new stock market crash, a pattern?”, in dutch  "Nieuwe beurskrach, een wetmatigheid?” was published  in a magazine “Tijdschrift voor economisch onderwijs” (magazine for economical education), a monthly publication of the VECON, A union of teachers in economic and social subjects in the Netherlands

Wim Grommen writes: This paper advances a hypothesis of the end of the third industrial revolution and the beginning of a new transition. Every production phase or civilization or human invention goes through a so- called transformation process. Transitions are social transformation processes that cover at least one generation. In this paper I will use one such transition to demonstrate the position of our present civilization. When we consider the characteristics of the phases of a social transformation we may find ourselves at the end of what might be called the third industrial revolution. The paper describes the four most radical transitions for mankind and the effects for mankind of these transitions: the Neolithic transition, the first industrial revolution, the second industrial revolution and the third industrial revolution.

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