behavioral finance: art or science? - qwafafew new...

Behavioral Finance: Art or Science?

Andreas CalianosARA Behavioral LLC

195 Church St.New Haven, CT 06510

Tel: (203) 497-8700

QWAFAFEW - NYCApril 26, 2005

2 © ARA Behavioral LLC

Selected Books:

Psychology of the Stock Market, G.C. Selden 1912

Studies in Stock Speculation, H.J. Wolf 1924

Why You Win or Lose: The Psychology of Speculation, Fred C. Kelly 1930

The Pre-History of Behavioral Finance

3 © ARA Behavioral LLC

No matter how you cut it, there are enormous emotional ups and downs involved in trading.~Paul Tudor Jones

Everything I have experienced suggests, at core, economic conditions and markets are grounded in the human psyche.~Robert Rubin

Existing theories about the behavior of stock prices are remarkably inadequate. ~George Soros

Others along the way….

4 © ARA Behavioral LLC

What is so intriguing is that [irrational exuberance] has characterized human interaction with little appreciable difference over the generations. Whether Dutch tulip bulbs or Russian equities, the market price patterns remain the same.~Alan Greenspan

From time to time individual investors may all act rationally but in combination produce an irrational result such as running for the exit in a theatre fire. ~Charles Kindleberger

Others along the way….

5 © ARA Behavioral LLC

Behavioral Finance isn’t new - Talking about it is.

"Behavioral Finance"Avg. Daily Occurance in Print Periodicals and Newspapers

0

20

40

60

80

100

120

140

160

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Source: LexisNexis

6 © ARA Behavioral LLC

EMH – The Rational (Straw) Man

7 © ARA Behavioral LLC

I don’t even know how to play checkers….

8 © ARA Behavioral LLC

He has lived too long and hasn’t prospered.

9 © ARA Behavioral LLC

Academic Behavioral Finance Poster Child

10 © ARA Behavioral LLC

Market Participants are Emotional and Make Errors

11 © ARA Behavioral LLC

If you’re Kirk, I must be….

12 © ARA Behavioral LLC

How can I capitalize on the human biases, errors and

mistakes of others if I exhibit them myself?

Academic Behavioral Finance Premise Irrationality

13 © ARA Behavioral LLC

….a/k/a The Pogo Paradox

14 © ARA Behavioral LLC

Minimize or Eliminate your OWN bad behaviors….

BF Rule #1

Requires disciplined, systematic approach to trading

and investing.

15 © ARA Behavioral LLC

Big Time Behavioral Finance

16 © ARA Behavioral LLC

Bull Markets are Trending Markets

17 © ARA Behavioral LLC

Bear Markets are Trading Markets

18 © ARA Behavioral LLC

Greed is not an emotion….

Self-interest underlies emotion.

Price Extremes are Emotional Extremes

19 © ARA Behavioral LLC

Emotional Investing 101

Price is the Journey between the poles of Hope and Fear.

Regret and Envy fuel the trip.

20 © ARA Behavioral LLC

BF Rule #2

The way we feel, act and think about the market is primarily a

function of our investment time horizon.

21 © ARA Behavioral LLC

Multiple Factors Produce Multiple Behaviors

• Time Horizon

• Directional Bias

• Risk Tolerance

• Competition for Capital

22 © ARA Behavioral LLC

Relative Performance is a Myth

At some threshold every relative return investor becomes an

absolute return investor.

23 © ARA Behavioral LLC

BF Rule #3

Tops are a Process.Hope fades slowly.

Bottoms are an Event.Fear compels action.

24 © ARA Behavioral LLC

Bullish Reversals

25 © ARA Behavioral LLC

Bearish Reversals