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Concepts of behavioral finance ...

Posted: Thu Apr 17, 2003 10:26 pm
by Robert Nio
An interesting paper about trading psychology ...

By Yale Professor Robert Shiller, a synthesis of most concepts found in behavioral finance.



Posted: Tue Apr 22, 2003 6:02 pm
by Forum Mgmnt
Robert, thanks for posting this.

I think that Behavioral Finance is starting to make technical analysis respectable, though, we can't call it "technical analysis" anymore.

Posted: Tue Apr 22, 2003 7:50 pm
by Robert Nio
That's probably true.

But, was there ever anything but quantified psychology?

Isn't any "technical" analysis just another way to describe crowd behavior ...

Posted: Wed Apr 23, 2003 7:20 am
by Forum Mgmnt
Anything in technical analysis that works is based on basic human psychology, whether the speculator's response to hope, greed, and fear, crowd psychology, or the behavior of the people doing hedging.

The problem has been that there have been so many snake oil salesman selling technical analysis as magic. There is so much mumbo-jumbo out there that the stuff that worked got lost in the mess and bogus claims.

Posted: Sat May 24, 2003 6:39 am
by rs
Here's some questions for anyone who is interested. They are things that I ponder on occasion!

If Human nature is the basis for the formation of trends and the fat tails of price distributions, then if human nature changed, would it lead to trend-following becoming unprofitable?

I would have to think that it would. If all traders in the market understood the concepts of behavioural finance and acted upon them, there would surely be no trends to take advantage of? In that scenario, then would countertrend methods become the only method of winning in the markets?

As c.f. mentioned, Behavioural finance is making technical analysis respectable. There are even courses on it being taught at MBA schools, including the one I am at. Is it possible that behavioural finance principles become the new orthodoxy and thus make trend following unprofitable?

Naturally, this process would take time, but it is certainly a possibility, in my opinion.

All views welcome...


Posted: Sat May 24, 2003 7:45 am
by Kiwi
A couple of questions in reply rs or maybe to add to yours.

Why would knowledge of behavioural finance make trend following unprofitable?

If there is a reason why knowledge would be enough - eg smoking and buying lottery tickets?

trading and behavioral finance

Posted: Sat May 24, 2003 8:00 am
by Mark Johnson
Just finished a book by Richard Thaler, one of the good ole Behavioral Finance boys, called The Winners Curse ( ... ingblox-20). He discusses several "anomalies", disagreements between economic theory and the real world. Traders may enjoy chapter ten, which touches upon a mechanical system for horserace betting, having positive expectation despite the huge commissions paid to the track.

It tickled me to read his summary at the end of the chapter on Calendar Effects in the Stock Market. (The January effect, the weekend effect, the monthend effect, the pre-holiday effect, etc. Everything Yale Hirsch has been publishing for 25 years.) His final sentence is rather jolly:

The challenge, then, is really to all economists to try to understand why the seasonal price movements occur, and how they can persist for at least 90 years, and for at least 50 years after heir existence has been published

Another poster here might take pleasure in crafting a similar sentence covering Donchian Breakouts and their worldwide publication in the 1963 edition of Playboy's Investment Guide :)

Posted: Sat May 24, 2003 8:09 am
by enigma
Hi rs,

Let me try to have a crack at this.

I think whether human nature changes or not is a matter of perspective. From one angle, people are always changing to adapt to new conditions, but on the other hand, emotions are always there, but what may have changed is how the emotions are triggered. Say fear for example ... you might be able to overcome your fear of a certain thing, but other fears remain and you may have developed new fears during that process. So fear is here to stay, although it may not be triggered by the same thing anymore. Going back to my point on perspective, I believe things can be looked as similar and as different as one wants them to be.

So for these reasons, I don't think anyone can truly understand behavioural finance because it's always evolving and, perhaps more importantly, we are part of the process, i.e. our own actions will affect the present and future. I think a suitable analogy would be a fish in the ocean .... a fish can learn how to deal with currents but they can never accurately anticipate the direction of a future current because that would require them to be out of the ocean to observe the direction of the impending waves.

Along similar lines, my personal belief is that the distribution of price returns in the markets can take on any shape (in the extreme sense). There will be periods where a normal distribution is suitable and others where leptokurtic (i.e. fat tails) distributions are better, but this can only be known with hindisght (would need to do my own research to back it up ... I may be wrong).

Of course, if one was to observe the historical distribution going back 100 years or so, then a fat tail is likely to be observed since all the rare events would be included in the analysis. But there may be regime shifts that render past distributions irrelevant for the future. In the end, the markets are man-made ... see my signature below :wink:

Posted: Wed Jul 16, 2003 12:25 am
by gfullmer
In regards to "Human Nature" perhaps a little bit of behavioristic talk might be appropriate. Just like trend followers say you don't have to look at much else besides price, the behaviorists say you don't have to look at much else besides behavior. Skinner would think that Seykota's Conscience Mind and his FRED are constructs that are not necessary to change behavior, especially self-destructive trading.

Here is a story that, if you are insightful, you might be able to relate it to trading. Before I was a Computer Science major, I was a Psychology major and had an experimental Psych class. We were allow to create our own experiment. I chose an interesting phenomenon in the literature that showed that if rats were trained to get food by pressing a lever they would work rather than to eat out of bowl full of food! I duplicated the experiment. I trained the rats on bar pressing. They had to press the bar to get the food (boxes that they do this in are called Skinner Boxes, named after a famous behaviorist - B. F. Skinner). Anyway, I randomized and trained them without the bar and with a paper plate and a variety of different mechanisms and sure enough the rats still would rather work for their food by pressing the bar.

So I tried to find out what was causing this "work ethic". I devised a box with two dispensers - two Skinner boxes put together - end to end. One end had a dispenser without a bar and the other had a dispenser with a bar. The one without the bar gave "free food" faster than the one with the bar, and they still went to "work out" on the bar! Then I think it was by accident I turned on the "click" to the dispenser that was giving free food and the rats went back to that continuely. My initial hypothesis from this experiment was that rats don't work for food but for the conditional reinforcer (the "click") associated with the food. Sure enough, when I took the click away, even after they had learned about the free food, they went back to the "earned" food. Other experiments confirmed this fact.

The condition reinforcer - those things that always happen within a second or two after a reward can have a powerful effect. What does this all mean? I don't know! Do you? ;-)

I later dropped out of Psychology after listening to the debate between Dr. Skinner and Carl Rogers (a humanistic psychologist) and let my hair grow long and became a flaming humanist (it was the late 60s and early 70s, after all) as I changed my major to Computer Science. Perhaps it was because of the "click" of the punched card machines! Rogers became my hero and would applaud Seykota's attempts at his Trading Tribe if he were still alive.


By the way you can't use TT anymore because Seykota has trademarked it! ;-)

Posted: Sat Aug 30, 2003 7:33 pm
by CRM114

Posted: Fri Oct 03, 2003 4:00 pm
by gfullmer
Very interesting. Thanks for the reference.

Instead of the American slang "Them that has gets" one might define the endownment effect as "Them that has keeps".


Posted: Tue Aug 03, 2004 11:47 am
by damian
From the McKinsley Quarterly, another article on this topic however with a business strategy slant.

Flaw 7: Misestimating future hedonic states.

There are also a few good sources in the footnotes.