Archives of “behavioral finance” tag

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12 Truths-Traders Should Know

  
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1. Stock prices run in cycles. Periods of re-pricing are usually quick and powerful and then they are followed by trendless consolidation.

2. Stocks are very highly correlated during drastic selloffs and during the initial stage of the recovery. In general, correlation is high during bear markets.

3. Bull markets are markets of stocks, where there are both winners and losers. When the market averages consolidate, there are stocks that will break out or down, revealing the intentions of institutional buyers.

4. In the first and last stage of a new bull market, the best performers are small cap, low float, low-priced stocks.

5. Try to trade in the direction of the trend. It is not only the path of least resistance, but also provides the best profit opportunities. Have a simple method to define the direction of the trend.

6. Traders’ attention (and market volume) is attracted by unusual price moves. Sudden price range expansion from a consolidaiton is often the beginning of a powerful new trend.

7. Opportunity cost matters a lot. Be in stocks that move. Stocks in a range are dead money. (more…)

Constructing Diversified Futures Trading Strategies

  
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  • Once you reach a few million under management, hiring a research staff to improve details is a good idea.
  • Wait for momentum to build in one direction and get on the bandwagon.  Expect to lose about two thirds of the time and so make sure your winners can pay for the losers and leave enough over to cover the rent.
  • Using a single strategy on a single instrument is for people with either extreme skill or for those who simply have a death wish
  • If we put the same notional dollar amount in each trade the portfolio would immediately be dominated by the volatile instruments and not much impact at all would come from the less volatile.
  • Trend following: Buying high and selling higher
  • Non professionals tend to spend an excess of time and energy on the buy and sell rules and neglect diversification and risk

Balenthiran 17.6 Year Cycle

  
  Education
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Interesting take on the longer term Secular Bear Market Vs. Cyclical Bull Market, via Kerry Balenthiran:

“My research has identified that a 17.6 year stock market exists within the markets consisting of downtrends lasting 2.2 years and uptrends lasting 4.4 years (2 x 2.2 years), with a combined cycle length of 17.6 years. I have called this cycle the Balenthiran Cycle and demonstrate how the intermediate turning points match stock market behavior going back to the early 1900s and extrapolate the cycle forwards to provide a market roadmap of the next secular bull market to 2035 and subsequent secular bear market to 2053.”

A few caveats: The 17.6 year cycle has been bantered about for a long time by various people. (See “previous” below).

Second, I would add is that cycles can be interrupted by external events — like Bailouts, QE, etc.

Last, the world changes over time, and I doubt that any oscillation period dependent upon humans would stay all that consistent over decades and centuries.

22- Books Everyone Should Read on Psychology and Behavioral Economics

  
  Education
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In no order and with no attribution:

  1. Risk Savvy: How to Make Good Decisions by Gerd Gigerenzer
  2. The Righteous Mind: Why Good People Are Divided by Politics and Religion by Jonathan Haidt
  3. The Checklist Manifesto: How to Get Things Right by Atul Gawande
  4. The Darwin Economy: Liberty, Competition, and the Common Good by Robert H. Frank
  5. David and Goliath: Underdogs, Misfits, and the Art of Battling Giants by Malcolm Gladwell
  6. Predictably Irrational, Revised and Expanded Edition: The Hidden Forces That Shape Our Decisions by Dan Ariely
  7. Thinking, Fast and Slow by Daniel Kahneman
  8. The Folly of Fools: The Logic of Deceit and Self-Deception in Human Lifeby Robert Trivers
  9. The Hour Between Dog and Wolf: Risk Taking, Gut Feelings and the Biology of Boom and Bust by John Coates
  10. Adapt: Why Success Always Starts with Failure by Tim Harford
  11. The Lessons of History by Will & Ariel Durant
  12. Poor Charlie’s Almanack
  13. Passions Within Reason: The Strategic Role of the Emotions by Robert H. Frank
  14. The Signal and the Noise: Why So Many Predictions Fail–but Some Don’tby Nate Silver
  15. Sex at Dawn: How We Mate, Why We Stray, and What It Means for Modern Relationships by Christopher Ryan & Cacilda Jetha
  16. The Red Queen: Sex and the Evolution of Human Nature by Matt Ridley
  17. Introducing Evolutionary Psychology by Dylan Evans & Oscar Zarate
  18. Filters Against Folly: How To Survive Despite Economists, Ecologists, and the Merely Eloquent by Garrett Hardin
  19. Games of Strategy (Fourth Edition) by Avinash Dixit, Susan Skeath & David H. Reiley, Jr.
  20. The Theory of Political Coalitions by William H. Riker
  21. The Evolution of War and its Cognitive Foundations (PDF) by John Tooby & Leda Cosmides.
  22. Fight the Power: Lanchester’s Laws of Combat in Human Evolution by Dominic D.P. Johnson & Niall J. MacKay.

Jesse Livermore Quotes -Must Read & Follow

  
  Education
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1) The stock market is never obvious. It is designed to fool most of the people, most of the time.

2) Play the market only when all factors are in your favor. No person can play the market all the time and win.There are times when you should be completely out of the market, for emotional as well as economic reasons.

3) Do not use the words “Bullish” or “Bearish.” These words fix a firm market-direction in the mind for an extended period of time. Instead, use “Upward Trend” and “Downward Trend” when asked the direction you think the market is headed. Simply say: “The line of least resistance is either upward or downward at this time.”Remember, don’t fight the tape!

4) The game of speculation is the most uniformly fascinating game in the world. But it is not a game for the stupid, the mentally lazy, the person of inferior emotional balance, or the get-rich-quick adventurer. They will die poor.

5) The only thing to do when a person is wrong is to be right, by ceasing to be wrong. Cut your losses quickly, without hesitation. Don’t waste time. When a stock moves below a mental-stop, sell it immediately. (more…)

The Two Trading Problems

  
  Education
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The old saying indicates that fear and greed are the emotions that dominate markets.

Eliminating emotion from trading is both impossible and undesirable. The “feel” for markets possessed by the best traders is a form of emotion; Antonio Damasio’s writings on this subject are must reading.

When we become very anxious or frustrated, however, our assessments of risk and reward are impaired: that is the enduring message of behavioral finance research. Regional cerebral blood flows no longer activate those executive parts of the brain responsible for planning, judgment, and decision-making. Rather, we regulate our motor activity as part of “flight or fight”. In the flight mode, we flee from risk and inhibit trading decisions. This leads to immediate safety, but also missed opportunity. In the fight mode, we confront risk and activate trading decisions. This leads to the relief of taking decisive action, but also poses increased possibilities of loss.

With market volatility at record levels, it’s not unusual to experience outsized losses when trades are wrong. These losses place a figurative magnifying glass on our flight or fight responses, activating stress modes at exactly the times we want to be most deliberate and planful. (more…)

Physics To Help Deal With Market Risks

  
  Education
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READANDLEARNMisako Takayasu, a Tokyo Institute of Technology associate professor, spoke with The Nikkei about how “big data” will be used in the future to help market players manage risks based on principles of physics.

Excerpts from the interview follow.

Q: How do you use big data in your research?

A: Big data has allowed us to record human behavior and analyze it mathematically. Broader economic or social phenomena can be observed more clearly (in this way), like particles in physics.

As more and more trading data is accumulated, it is becoming increasingly possible to analyze and predict fluctuations using methods common in physics. The exponential growth of computer calculation speeds has also helped the process.

Q: What can you deduct from market data using these tools?

A: Data on ticks — the smallest increment of movement in the price of a security — can be used to gauge investor sentiment and how volatility is triggered. Market swings cannot be explained by a simple random-walk theory.

Markets become more stable when the number of contrarian investors increases. Conversely, they become unstable when more and more investors follow a market trend.

If market-followers dominate a market as it continues to climb, it will crash in the end. We may be able to explain the dynamics of a bubble with big data.

Q: What are the possible applications of big data in the market? (more…)

What to Monitor During a Correction

  
  Education
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  • Bull market correctionReversed for bear market correction.
    • Support below
    • Fibonacci retracement levels of prior uptrend
    • Bottoming price action
    • Positive divergence — index vs. indicators
    • Positive divergence — index vs. internals
    • Bullish candlestick pattern or western reversal bar
    • Notable change in scan hits
    • Break of resistance (downward sloping) trendline

Classifying Bull Market Declines

  • 1 to 3% – Market pullback
  • 3 to 5% – Minor correction
  • 5 to 8% – Standard correction
  • 8 to 12% – Deep correction
  • 12 to 16% – Very deep correction
  • 16 to 20% – Minor bear market
  • More than 20% – Bear market

MRI’s of Succesful Traders

  
  Education
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I’ve seen this study making the rounds on several websites now as a type of neuroeconomic confirmation of Buffetological principles…

Perhaps procedure might be slightly useful as a means of seeing physical brain improvement by training– such as that found through meditative practices.

“Traders who buy more aggressively based on NAcc signals earn less. High-earning traders have early warning signals in the anterior insular cortex before prices reach a peak, and sell coincidently with that signal, precipitating the crash. These experiments could help understand other cases in which human groups badly miscompute the value of actions or events.”

“Neuroeconomists Confirm Warren Buffet’s Wisdom”:

“Seeing what’s going on in people’s brains when they are trading suggests that Buffett was right on target,” says Colin Camerer, the Robert Kirby Professor of Behavioral Economics at Caltech.

That is because in their experimental markets, Camerer and his colleagues found two distinct types of activity in the brains of participants—one that made a small fraction of participants nervous and prompted them to sell their experimental shares even as prices were on the rise, and another that was much more common and made traders behave in a greedy way, buying aggressively during the bubble and even after the peak. The lucky few who received the early warning signal got out of the market early, ultimately causing the bubble to burst, and earned the most money. The others displayed what former Federal Reserve chairman Alan Greenspan called “irrational exuberance” and lost their proverbial shirts.

7 Ways Your Brain Is Making You Lose Money

  
  Education
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“Investors are ‘normal,’ not rational,” says Meir Statman, one of the leading thinkers in behavioral finance. Behavioral finance aims to better understand why people make the financial decisions they do. And it’s a booming field of study. Top behavioral finance gurus include Yale’s Robert Shiller and GMO’s James Montier. It’s also a crucial part of the Chartered Financial Analyst (CFA) curriculum, a course of study for financial advisors and Wall Street’s research analysts. We compiled a list of the seven most common behavioral biases. Read through them, and you’ll quickly realize why you make such terrible financial decisions.

Read. However, once you get the idea of behavioral finance, keep in mind that the names associated with this article don’t have a wise strategy. Trend following is wise. Predictions, forecasts and other la la statements about what might happen tomorrow are only useful if you are masochist.

 

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