Archives of “behavioral finance” tag

rss

George Soros quotes

  
  Education
#  #  #  #  #  #  #  #  #
The Hungarian-born financier will therefore no longer be able to move markets. But many of his aphorisms and apothegms will long continue to apply. Here are some of the best.
QuoteWhen I see a bubble forming I rush in to buy, adding fuel to the fire. That is not irrational.”
QuoteWell, you know, I was a human being before I became a businessman.”
 
Markets are designed to allow individuals to look after their private needs and to pursue profit. It’s really a great invention and I wouldn’t under-estimate the value of that, but they’re not designed to take care of social needs.”
QuoteThe financial markets generally are unpredictable. So that one has to have different scenarios… The idea that you can actually predict what’s going to happen contradicts my way of looking at the market.”
 

(more…)

The Difference Between A Good And A Bad Trader: What Brain Imaging Reveals

  
  Education
#  #  #  #  #  #  #  #  #  #  #  #

The age old question: what is the difference between a good trader and a bad trader… aside from the P&L at the end of the day of course.

While luck has always been a major component of the equation, figuring out just what makes one trader successful, while another blows all his funds on a trade gone horribly bad has always been the holy grail of behavioral finance. Because if one can isolate what makes a good trader “ticks, that something can then be bottled, packaged and resold at a massive markup (and thus, another good trade) in the process making everyone the functional equivalent of Warren Buffett.

Or so the myth goes. Alas, the distinction between the world’s only two types of traders has been a very vague one.

Until now. (more…)

Book Review: Priceless

  
  Education
#  #  #  #  #  #  #  #  #  #  #  #  #  #  #  #  #  #  #  #

This book, Priceless: The Myth of Fair Value (and How to Take Advantage of It), covers rationality in decision making, and how markets and marketers take advantage of the deficiencies in rationality in average people.

There are many in the investment community that admire behavioral finance, and many who say that it might be true, but where are the big profits to be made from it?

This book doesn’t cover behavioral finance per se, but it does cover its analogue in pricing and marketing.  In a negotiation, the first person to put a price on the table tends to push the final price agreed to closer to his price.  Leaving aside no-haggle dealerships, why do car dealers post high prices for vehicles?  Because only a minority does the research to understand what the minimum price is that a dealer will accept.  The rest pay more, often a lot more.  Personally, I do a lot of research before I buy a car, and it helps me spot dealer errors in pricing.

The book is replete with examples of how there is no “fair” way to price things out.  What are the proper damages for a jury settlement?  The attorney for the plaintiff is incented to come up with the highest believable amount for the jury, because they will render a verdict less than that.  Make the ceiling as high as possible, and the plaintiff will get more.

We call placing the first price on the table “anchoring,” because it pulls the final result toward itself.  The book is filled with experiments dealing with anchoring.

The book also spends a lot of time on the “ultimatum game,” where a person gets $10, and must offer some of it to a second person, but if the second person turns him down, the first person gets nothing.  The main lesson here is that pride is stronger than greed.  Yes, it can be construed as a question of fairness, but when someone gives up money to deny money to someone else, it is not fairness but envy.  Why pay to make someone else worse off?  To teach him a lesson?  What an expensive lesson.

Much of this book was a walk down memory lane for me.  I discovered Kahneman and Tversky in the Fall of 1982, and I found their ideas to be more cogent than much of the “individuals maximize utility” cant that was commonly heard from most professors teaching microeconomics.  People are far more complex than homo oeconomicus.  Small surprise that most tests of microeconomics as a system are not confirmed by the data.

Kahneman and Tversky showed via a wide array of examples that the decisions people make are affected by the way they are presented to them.  People can be manipulated in limited ways in order to affect the decisions that they make. (more…)

Defination -RUMOR

  
  Education
#  #  #  #  #  #  #  #  #

Rumors have always been the fuel of financial markets. The modern Wall Street saying “Buy on the rumor, sell on the news” would not have been surprising to any Dutch trader in the 17th century. As Joseph de la Vega wrote in Confusion de Confusiones, his book about the Amsterdam Stock Exchange, in 1688:

The expectation of an event creates a much deeper impression upon the exchange than the event itself. When large dividends or rich imports are expected, shares will rise in price; but if the expectation becomes a reality, the shares often fall; for the joy over the favorable development and the jubilation over a lucky chance have abated in the meantime.

The figures shown at the right in this painting of the Amsterdam exchange, painted around the time of de la Vega’s book, appear to trading the latest hot rumor:

The Courtyard of the Stock Exchange, by Job Andriaenszoon Berckheyde (ca. 1670-1690), http://www.amsterdammuseum.nl/

 Deliberately spreading false rumors was one of the most effective tactics for profiting on stocks in the 18th century. In his pamphlet “The anatomy of Exchange-Alley,” published in 1719, Daniel Defoe wrote: (more…)

Reminiscences of Marty Zweig: What I Learned From a Market Great

  
  Education
#  #  #  #  #  #  #  #  #

The early years

After degrees from Wharton, University of Miami and Michigan State, Marty started his career in academia but ultimately became one of the most respected stock market “gurus” in the modern era. I have years’ worth of memories of Marty, and hope readers will indulge me as I reminisce and share some of the most important market lessons I learned from one of the greats.

But first, the personal stuff. Marty was brilliant, there’s no doubt; but he was also quirky, goofy and affable. He was the consummate worrier… but he was also the ultimate warrior. He lived, ate and breathed the markets and perpetually (and tirelessly) strived to “figure it out.”

One of my greatest memories is getting to see first-hand his now-famous memorabilia collection—to which there are no comparables. Among them, there was the dress Marilyn Monroe wore while singing Happy Birthday to John F. Kennedy in 1962; the suits worn by the Beatles on the Ed Sullivan Show in 1964; the 1992 Olympics’ US “Dream Team” basketball jerseys; the booking sheet from one of Al Capone’s arrests; a letter from Madonna to Michigan State declining acceptance so she could pursue a music career; guitars of many rock stars, including Bruce Springsteen and Jimi Hendrix; the fedora worn by Humphrey Bogart in Casablanca; the original Terminator costume worn by Arnold Schwarzenegger; and multiple boxing championship belts, Super Bowl rings and Heisman Trophies. (more…)

Daniel Kahneman: The riddle of experience vs. memory -VIDEO

  
Education, Video
#  #  #  #  #  #  #  #

Using examples from vacations to colonoscopies, Nobel laureate and founder of behavioral economics Daniel Kahneman reveals how our “experiencing selves” and our “remembering selves” perceive happiness differently. This new insight has profound implications for economics, public policy — and our own self-awareness

 

How does the mind of a trader work?

  
  Education
#  #  #  #  #  #  #  #  #  #  #  #  #  #  #

MindpowerIn order to understand behavioral finance and crowd behavior on the capital market, first of all we need to understand the factors that influence the trader mindset. Traders are “misled” by many things. Let us put these factors in two main categories, depending simply on their source, external or internal.

The most important external factor is “everyone else”, the trading crowd, the general opinion. We form an opinion about the others. We believe them to be either smart or stupid, either right or wrong, then choose one of the two main psychological trading strategies: “go along to get along” or be a contrarian. Then we have other external factors like payoffs, scale, psychological and academic background, social structure, external advisory and resources. (more…)

Speculation, Trading, and Bubbles-by José A. Scheinkman (Book Review )

  
  Education
#  #  #  #  #  #  #  #  #  #  #  #

SPECULATION-TRADING-BUBBLESTo pay tribute to one of its most famous graduates, Kenneth J. Arrow, Columbia University launched an annual lecture series dealing with topics to which Arrow made significant contributions—and there were many. Speculation, Trading, and Bubbles stems from the third lecture in the series given by José A. Scheinkman, with adapted transcripts of commentary by Patrick Bolton, Sanford J. Grossman, and Arrow himself. I’m going to confine myself here to a few excerpts that encapsulate some of the lecture’s key points, ignoring the often perceptive commentary.
Scheinkman offers a formal model of the economic foundations of stock market bubbles in an appendix to his lecture, but he lays out its basic ideas in the lecture proper. The model rests on two fundamental assumptions—“fluctuating heterogeneous beliefs among investors and the existence of an asymmetry between the cost of acquiring an asset and the cost of shorting that same asset. … Heterogeneous beliefs make possible the coexistence of optimists and pessimists in a market. The cost asymmetry between going long and going short on an asset implies that optimists’ views are expressed more fully than pessimists’ views in the market, and thus even when opinions are on average unbiased, prices are biased upwards. Finally, fluctuating beliefs give even the most optimistic the hope that, in the future, an even more optimistic buyer may appear. Thus a buyer would be willing to pay more than the discounted value she attributes to an asset’s future payoffs, because the ownership of the asset gives her the option to resell the asset to a future optimist.” (pp. 15-16)

(more…)

Decision-Making and Emotional Arousal

  
  Education
#  #  #  #  #  #  #  #  #  #  #  #  #  #  #  #  #  #  #

For years, behavioral finance researchers have been aware that people’s decision making is greatly affected by how choices are framed. For instance, the same monetary bet framed as a choice between a certain vs. risky gain and a certain vs. risky loss elicits very different choices. (We tend to take certain gains, but will seek risky losses to avoid certain loss). Studies using functional magnetic resonance imaging (fMRI) find that we expend less cognitive effort in taking a sure gain than in choosing risky gains, sure losses, or risky losses. It may well be that traders don’t let their profits run simply because they take the easy way out cognitively. Conversely, traders may be reluctant to set and follow stops because of the greater cognitive effort required. 

It turns out, however, that this taking the easy way out and avoiding difficult decisions may not be a function of laziness. A very interesting investigation coming out of the Institute of Neurology at University College London finds that the framing effect on decision making is mediated by an emotional center within the brain: the amygdala. This is the same brain center that cognitive neuroscientist Joseph LeDoux has linked to our response to stress and trauma. 

The implications are significant. When blood flow is directed away from the brain’s executive center, the frontal cortex, and the amygdala and associated emotional centers are activated, we are likely to underutilize those executive functions–reasoning, judgment, planning–and respond to our (emotional) framing of choices with a lack of effort. Going with our feelings might just be the reason we don’t think through our choices.  (more…)

Get Rs 25000 right now or flip a coin with a 50/50 chance of winning Rs 50000. Which do you go for?

  
  Education
#  #  #  #  #  #

Think of an answer before reading further.

Now. You have the choice of definitely losing  RS 25000 or flipping a coin with a 50/50 chance of losing Rs 50000. Which option do you take?

If you answered both questions the same way, congratulations, you have a rational attitude toward gains and losses. That’s good news if you’re a trader.

Studies show that most people will pick receiving Rs 25000 while opting to take the chance of losing Rs 50000 or nothing. It’s called loss aversion and it’s because negative reactions to loss impact our psyches twice as hard as the rush of making gains does.

Master that psychological part of trading and you’re one step closer to being the trader you want to be.

Go to top