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Hank Pruden on "Behavioral Finance" and Technical Analysis

  
  Education
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Hank Pruden’s theory of “Behavioral Finance” proposes that human flaws are consistent, measurable and predictable, and being aware of and utilizing this phenomenon can benefit a trader.

“For the better part of 30 years, the discipline of finance has been under the thrall of the random walk\cum efficient market hypothesis. Yet enough anomalies piled up in recent years to crack the dominance of the random walk. As a consequence, the popular press has been reporting the market behavior,” said Pruden. One of these new methods discussed is “behavioral finance.”

Pruden is a professor in the School of Business at Golden Gate University in San Francisco. He was a featured speaker at the 20th annual Telerate Seminars Technical Analysis Group Conference (TAG 20). (more…)

Weatherall, The Physics of Wall Street-Book Review

  
  Education
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The Physics of WALL STREETJames Owen Weatherall’s The Physics of Wall Street: A Brief History of Predicting the Unpredictable (Houghton Mifflin Harcourt, 2013) is an engrossing book. Even though I was familiar with many of the stories the author recounts, at no point was I tempted to skip a page. Coming from me, that’s high praise indeed.

In the first chapter Weatherall takes the reader on a journey from sixteenth- and seventeenth-century attempts at a systematic theory of probability (Cardano, de Méré, Pascal, and Fermat) through Bachelier’s 1900 dissertation, A Theory of Speculation. Bachelier is credited with having come up with the random walk model/efficient market hypothesis. Like many quants, he was ahead of his time. “In a just world, Bachelier would be to finance what Newton is to physics. But Bachelier’s life was a shambles, in large part because academia couldn’t countenance so original a thinker.” (p. 27)

It wasn’t until Maury Osborne’s 1959 paper entitled “Brownian Motion in the Stock Market,” similar in both topic (predicting stock prices) and solution to Bachelier’s thesis, that people began to understand that physics could make a substantial contribution to finance. By then, as Osborne said, “Physicists essentially could do no wrong.” (p. 28) Scientists were in demand in industry, research facilities, and government. Pre-The Graduate, think nylon and the Manhattan Project.

Osborne found that stock prices don’t follow a normal distribution as Bachelier had suggested; rather, the rate of return on a stock (the “average percentage by which the price changes each instant”) is normally distributed. “Since price and rate of return are related by a logarithm, Osborne’s model implies that prices should be log-normally distributed.”  (more…)

Random Walk?

  
  Education
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 This book almost convinced me that the markets are a random walk. I can’t really go into the details of why – you have to read it all before this impression begins to sink in. Compound this with the fact that all in all the economists of the world have said “we have no idea why the markets do what they do.” – Thats their conclusion.

So if they have no idea, what chance have I got? You may find within yourself some buried little impulse to “figure this thing out, once and for all.” – I know what thats like. You look at a chart, and you feel as though its on the tip of your tongue, just out of the minds reach if you will. You know that feeling? As if a thin veil could be lifted and you’d see the inner mechanics of it all. You won’t. Many have gone before you who tried, and still you don’t know where price will go next.

I think what happens is that if we make a certain call in one direction, and price happens to go in our direction, we say “I WAS RIGHT”… But we pay less emphasis when we were wrong. Its the old thing of when you want to buy a yellow VW you see them everywhere all of a sudden.

The impression left by the reading of this book doesn’t so much make me want to throw my hands in the air and give up, but rather it emphasizes the importance of things like risk/reward and high probability. Its not about being right or wrong. I also want to do some research into game theory, which is something that was touched on in the book. Its good how this subject constantly throws up new branches of learning.

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