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


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….


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….


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

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

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20

40

60

80

100

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160

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

Source: LexisNexis


EMH – The Rational (Straw) Man


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


He has lived too long and hasn’t prospered.


Academic Behavioral Finance Poster Child


Market Participants are Emotional and Make Errors


If you’re Kirk, I must be….


How can I capitalize on the human biases, errors and

mistakes of others if I exhibit them myself?

Academic Behavioral Finance Premise Irrationality


….a/k/a The Pogo Paradox


Minimize or Eliminate your OWN bad behaviors….

BF Rule #1

Requires disciplined, systematic approach to trading

and investing.


Big Time Behavioral Finance


Bull Markets are Trending Markets


Bear Markets are Trading Markets


Greed is not an emotion….

Self-interest underlies emotion.

Price Extremes are Emotional Extremes


Emotional Investing 101

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

Regret and Envy fuel the trip.


BF Rule #2

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

function of our investment time horizon.


Multiple Factors Produce Multiple Behaviors

• Time Horizon

• Directional Bias

• Risk Tolerance

• Competition for Capital


Relative Performance is a Myth

At some threshold every relative return investor becomes an

absolute return investor.


BF Rule #3

Tops are a Process.Hope fades slowly.

Bottoms are an Event.Fear compels action.


Bullish Reversals


Bearish Reversals

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