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Unlocking Behavioral Finance: Insights and Indicators

Explore the blend of personal behavior and corporate finance in this evolving area of study. Learn about market indicators such as sentiment, flow of funds, and market structure to enhance financial decision-making. Discover how behavioral explanations and technical analysis can influence asset returns. Delve into the nuances of trading signals, historical patterns, and the impact of market breadth. Navigate through real-world charts and empirical findings to grasp the interplay of human behavior and financial markets.

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Unlocking Behavioral Finance: Insights and Indicators

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  1. CHAPTER 19 Behavioral Finance and Technical Analysis

  2. Behavioral Finance • Traditional theory ignores some aspects of personal behavior • Behavioral finance tries to incorporate personal behavior to extend corporate finance • Behavioral finance is a developing area

  3. Individual Behavior • Cooperation and Altruism • Bidding and the Winner’s Curse • Endowment Effect, Status Quo Bias and Loss Aversion • Mental Accounts

  4. Figure 19-1 Loss Aversion Preference Function

  5. Asset Returns and Behavioral Explanations • Calendar effects • Cash dividends • Overreaction and mean reversion

  6. Explanations that Fail the Empirical Test • Controversial explanations from behavioral finance • Closed-end fund pricing • Excess volatility in stock prices • Loss Aversion and CBOT Traders

  7. Charting • Dow theory • Point and figure charts • Candlestick charts • Actual versus simulated results

  8. Figure 19-2 Dow Theory Trends

  9. Figure 19-3 Dow Jones Industrial Averages in 1988

  10. Figure 19-4 Point and Figure Chart for Table 19-2

  11. Table 19-2 Stock Price History

  12. Figure 19-5 Point and Figure Chart for Atlantic Richfield

  13. Figure 19-6 Candlestick Chart

  14. Figure 19-7 Actual and Simulated Stock Prices for 52 Weeks

  15. Figure 19-8 Actual and Simulated Changes in Weekly Stock Prices for 52 Weeks

  16. Sentiment Indicators Trin Statistics # Advancing / # Declining Volume Advancing / Volume Declining # Declining / Volume Declining # Advancing / Volume Advancing If Trin > 1.0 bearish signal

  17. Sentiment Indicators • Put / Call Ratio • Historical value 65% • When higher than 65% a signal occurs • Bearish view • Bullish view • Mutual Fund Cash Position • Cash levels are low - bearish sign • Cash levels are high - bullish sign

  18. Sentiment Indicators Odd - Lot Trading • Ratio of odd-lot purchases to odd-lot sales • When ratio exceeds 1.0, bearish sign • Contrarian logic - small investors are the last to buy in bull markets

  19. Flow of Funds Indicators • Short Interest - total number of shares that are sold short • When short sales are high a signal occurs • Bullish interpretation • Bearish interpretation • Credit Balances in Brokerage Accounts • Investor leave balances when they plan to invest in the future • When levels are high a bullish sign

  20. Market Structure Indicators Moving Averages • Average price over some historical period (5 weeks or 200 days) • When current price crosses the average a trading signal occurs • Bullish signal when the current price rises above the moving average • Bearish sign when the current price falls below the moving average

  21. Figure 19-10 Moving Average for Microsoft

  22. Figure 19-11 Moving Averages

  23. Market Structure Indicators Breadth • The extent to which movements in a broad index are reflected widely in movements of individual stocks • Spread between advancing stocks and declining stocks • Also used in industry indexes

  24. Table 19-4 Breadth

  25. Figure 19-12 Cumulative Difference in Returns of Previously Best and Worst Ranking Stocks in Subsequent Months

  26. Value Line System • Widely followed with some evidence of superior performance • Value Line System is predominately a technical system • Earnings momentum • Relative stock prices • Ratios of moving averages

  27. Figure 19-13 Record of Value Line Ranking for Timeliness (without adjustment for change in rankings) 1965-1990

  28. Value Line System • Paper vs actual performance indicates that the system is difficult to implement • Value Line Fund has not shown superior performance • High turnover costs are associated with the strategy • Evidence shows prices react quickly to reported ranking changes

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