How to study Stock market trends - Ron Insana Things don’t always work as they should on Wall Street. However, financial markets send signals about the future of the economy. Markets can move in advance of what is known to the general public. In a broad view, markets seemingly anticipate political events. In other times, the markets will anticipate economic events long before the investing public understands what’s going on in the general economy. The market is also good at discounting a transformational event. When the market more than anticipates all future revenues and all the future profits that would accrue to the new phenomena, a bubble or mania develops. The most interesting part of the mania is the repetitive nature of the phenomenon …show more content…
Economists have liked to invoke the principle of rationality as an underlying component of their theory on EMH. This has been useful but it’s limited because people are not completely rational. Humans have limits. We are aware of other people’s weakness and have a tendency to exploit weaknesses. Psychologists, Daniel Kahneman and Amos Tversky, created what is considered the most famous element of behavioral economics; prospect theory. Prospect theory is a theory of how people form decisions about prospects. A prospect is a gamble or a decision made about uncertainty. Within prospect theory, the value function represents how people value things. The weighting function infers how people deal with probabilities. People don’t weigh gains and losses the same. What they found is that people’s value or utility diminishes as they gain more. But for losses, it’s the …show more content…
A probably is measured between zero and 100%. Kahneman and Tversky noted that for very small probabilities, people round the probability to zero. For high probabilities, people round up to one. If people decide not to round the probability to zero or one, they exaggerate the difference between zero and one. For most people, there are three probabilities; the event can’t happen, the event might happen or the event will happen. Prospect theory explains much of what happens in finance, but prospect theory doesn’t explain everything. Other biases, such as overconfidence and cognitive dissonance, cloud thinking. The tendency for overconfidence produces anomalies and opportunities for manipulation. Cognitive dissonance is a judgmental bias people tend to make as they can’t admit when they are wrong. People will cling to old beliefs and try to find evidence to support their beliefs because they have an ego involvement with the
It is often said that perception outweighs reality and that is often the view of the stock market. News that a certain stock may be on the rise can set off a buying spree, while a tip that one may be on decline might entice people to sell. The fact that no one really knows what is going to happen one way or the other is inconsequential. John Kenneth Galbraith uses the concept of speculation as a major theme in his book The Great Crash 1929. Galbraith’s portrayal of the market before the crash focuses largely on massive speculation of overvalued stocks which were inevitably going to topple and take the wealth of the shareholders down with it. After all, the prices could not continue to go up forever. Widespread speculation was no doubt a major player in the crash, but many other factors were in play as well. While the speculation argument has some merit, the reasons for the collapse and its lasting effects had many moving parts that cannot be explained so simply.
In the same vein, the housing bubble is similar to Michael Lewis’ “Liar’s Poker” in which, two of Lewis’ co-workers gamble and bluff their way to win the game (653-657). “Liar’s Poker” is a great personification of how Wall Street works. Most stockbrokers gamble and bluff their way through economic situations however, gambling and bluffing can only get you so far. Alternatively the same is said about
Over the past decade, scientists have conducted research on the effects of a belief in determinism, a belief that one acts with predetermined outcomes, on behavior and values of people. In two 2008 studies,
Markets have a big impact on the economy of any country. In the United Kingdom, one of the main markets that effects its economy is the housing market. According to FTI Consulting LLP (“FTI”) (2012) housing is of intrinsic importance to the economy and society. Housing has a dual role as: a human need, through its functional use as somewhere to live and the influence of its attributes on people’s well-being; and an asset, given that for many it is a long term investment which represents a large proportion of their wealth. The housing market is divided into two main types, the first type of housing market is known as the rental market where tenants rent properties from landlords (Anderton, 2008). The second type of housing market is the owner-occupied market where people buy a property in order to live in it (ibid). In recent years, several non-price factors have led to the increase of property prices in the United Kingdom. These factors are subcategorized into non-price factors of demand and supply. According to Anderton in Economics (2008) “demand is the quantity of goods and services that will be bought at any given price over a period
Imagine a challenge that tests our ideas about money and how we respond to it under certain conditions. This test involves the auction of a twenty-dollar bill with very simple rules. The highest bidder will get the bill and the second highest bidder receives nothing but pays the amount of the losing bid. As the test progresses players in the room bid above the face value ending the bid at twenty-eight dollars. The question now is, ‘Why would anyone want to pay above the face value?’ Behavioral economists believe that when decisions are made on value, the human mind often behaves irrationally. People judge value based on prior knowledge fed to them at some point in their lives and not something thoroughly researched. This is the kind of misinformed
] This catastrophic event is caused by the accumulation of a large scale of speculation by not only investors but also banks and institutions in the stock market. Though the unemployment rate was climbing during the 1920s and economy was not looking good, people on Wall Street were not affected by the depressing news. The optimism spread from Wall Street to small investors and they were investing with the money they don’t have, which is investing on margin as high as 90%. When the speculative bubble burst, people lost everything including houses and pensions. The main reason ...
This statement might be economic theory, but it also might be a theory about human nature as well. It could explain why it is, that when human beings are prohibited from having something that they want, (especially by others who feel they are superior), they will go to any length to get it.
This essay touched on the topics of Negativity Bias, Confirmation Bias, and Gamblers Fallacy, and Illusion of control. Each is just a few samples of a massive plethora of biases and theories based upon humanity. Most people have certain biases that govern their subconscious and will trigger if certain scenarios are met. It is hard to change some effects, like confirmation bias, after it has occurred because it easier to go along with preconceived notion rather than put the effort in reshaping thought
The theory of Nash equilibrium by John Nash (1951) has been a central concept in game theories and further more for a wide range from economics even to the social and environmental sciences studies. Besides the game theory, David (2012) has recalled that, there are three unrealistic traits of standard economic model of human behavior – “unbounded rationality, unbounded willpower, and unbounded selfishness – all of which behavioral economics modifies.” However, consider the assumption of Nash equilibrium theory, there is a hypothesis about all players in the game they are rational and understand the rule of the game. Which means they do know about their opponents choices and what reaction they are going to choose with the goal of profit maximization (or their own objectively goal). In the following there will be a further discussion and line out the practicality of Nash equilibrium.
Investment theory is based upon some simple concepts. Investors should want to maximize their return while minimizing their risk at the same time. In order to accomplish this goal investors should diversify their portfolios based upon expected returns and standard deviations of individual securities. Investment theory assumes that investors are risk averse, which means that they will choose a portfolio with a smaller standard deviation. (Alexander, Sharpe, and Bailey, 1998). It is also assumed that wealth has marginal utility, which basically means that a dollar potentially lost has more perceived value than a dollar potentially gained. An indifference curve is a term that represents a combination of risk and expected return that has an equal amount of utility to an investor. A two dimensional figure that provides us with return measurements on the vertical axis and risk measurements (std. deviation) on the horizontal axis will show indifference curves starting at a point and moving higher up the vertical axis the further along the horizontal axis it moves. Therefore a risk averse investor will choose an indifference curve that lies the furthest to the northwest because this would r...
An 'economic cost-benefit analysis' approach to reasoning sees actions favoured and chosen if the benefit outweighs the cost. Here, the benefits and costs are in the form of economic benefits and costs, such as, monetary loss or profit. One who is motivated by such an approach will deem a course of action preferable if doing so results in an economic profit. Conversely, actions will be avoided if they result in an economic loss (Kelman 1981).
A crucial reason in favour of mental accounting and overconfidence is decision efficiency. Real-life investing scenario changes every moment Time-consuming and systematic thinking process seldom is allowed during the intense decision-making (Stewart Jr et al., 1999, Busenitz and Barney, 1997). Additionally, the ‘small world’ used by the economic theory, which only applied to strict condition, is not necessarily applicable in the practical investment decision. As the assumption in those analysis approach may not conform with real life well and for most of times, cognitive heuristics is more suitable for the uncertainty(Gigerenzer and Gaissmaier, 2011). However, there is also a few argument against them, for it may hinder people from examining their investment choice thoroughly. Research shows that they did not perceive themselves as risk taker, but in fact, they are more likely to take relatively low return alternatives as ‘opportunities’, indicating that they are risk-taking to a great extent(Palich and Ray Bagby, 1995). As a result of the illusion created by such factors, decision makers tend to be narrow-minded in composing strategies and unable to bring enough information into thought(Schwenk, 1988). It was demonstrated by several researches that decisions made by means of biases and heuristics impose
...ke them do what they really want is to have more money and ended up not thinking about the consequence and that’s all subjective expected utility (SEU) is all about. That is why this theory is a dominant theory because what it based upon people and what they really think about in normal day-to-day challenge or decision making a person makes. When an officer is on duty and there was a robbery going on and people are hurt inside the store and outside who have been shot. They need to quickly decide to whether chase the criminals or aid the civilians who have been wounded by the criminal. The everyday decision sometimes unconsciously decided and not knowing we either we are doing the right thing or just going through the motion of what we are doing. People can die or have the penalty of death if a person chooses the wrong decision and doesn’t know why he or she did it.
The stock market is an essential part of a free-market economy, such as America’s. This is because it provides companies the capital they need in exchange for giving away small parts of ownership in their company to investors. The stock market works by letting different companies sell stocks to gain capital, meaning they sell shares of their company through an exchange system in order to make more money. Stocks represent a small amount of ownership in a company. The more stocks a person owns, the more ownership they have of that company. Stocks also represent shares in a company, which are equal parts in which the company’s capital is divided, entitling a shareholder to a portion of the company’s profits. Lastly, all of the buying and selling of stocks happens at an exchange. An exchange is a system or market in which stocks can be bought and sold within or between countries. All of these aspects together create the stock market.
In the modern world, financial markets play a significant role, with huge volumes of everyday dealings. They form part of contemporary economic lifestyle and determine the level of success of many people. Humans have always been uncertain of what the future holds and thus, tried to forecast it. The forecast of course cannot omit the likelihood of “easy money” by forecasting the prices of equity markets in the future.