Online Stock Trading | Psychology - Behavioral Finance

Psychology - Behavioral Finance


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Just came across a wonderful research article from Stanford University.  Here is a glimpse of it:

Where Stock Market Psychology and Pricing Intersect
by:  Harrison G. Hong & Ming Huang

STANFORD GRADUATE SCHOOL OF BUSINESS — At the zenith of the dot-com craze when Palm Inc. spun off from parent 3Com Corp., its March 2, 2000, IPO touched off a stampede of over-eager investors elbowing their way into the action. When the dust settled at the end of the day, Palm’s worth surpassed its parent, even overtaking such titans as Ford Motor Co. and General Motors Corp. Stock market watchers scratched their heads and wondered why investors didn’t run up 3Com stock as a cheaper route to Palm.

“3Com owned 94 percent of Palm,” points out Ming Huang, an associate professor of finance at the Stanford Graduate School of Business who has conducted research in the emerging field of behavioral finance. “Yet Palm was trading so high right after its IPO that 3Com’s value was much lower than Palm’s. That didn’t make any sense.”

In academia, financial economists were hard put to explain this and other overheated stock behavior in the frenzied months leading up to the bursting of the dot-com bubble. The highly irrational pricing of Internet stock—especially at IPO—did not square with the traditional approach to the study of financial markets, which assumes that markets are always efficient and participants always rational. The traditional view that “smart money” in the market will take advantage of mistakes and human foibles and thereby drive prices back to equilibrium could not explain the collective faulty judgment of a broad base of investors and their impact on stock prices.

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Psychology is a wonderful tool for a trader to understand.  Jesse Livermore believed that one’s emotional balance was his key to success.  He should know, when Mr. Livermore was at his best his life was in order.  It was when he began losing the mental edge and allowing outside influences ruin his emotional balance.

I like to equate to when Tiger Woods is coming into the final round of a major.  He like many other great athletes have the ability to control his emotional balance to allow himself to achieve victory.  A trader must do the same.  You can not dwell on trades that have not gone your way or focus solely on one or many losing trades.  Strict study and sustaining a balance will allow you to achieve stock market success.  There is not place for fear, hope, or greed.

Market Speculator

*Check out more research papers here. 
**Article from Stanford University - Graduate School of Business

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Comments

2 Responses to “Psychology - Behavioral Finance”

  1. Gio on July 5th, 2007 6:04 am

    Hey MS,

    Great site! Very clean and professional looking. Am I the first to post a comment? Ha, I’m sure you’ll have more to come.

    Anyway, any thoughts on the 5% drop in China market ?[http://biz.yahoo.com/ap/070705/china_markets.html?.v=6] Do you think it will have a big impact on our market? What about Chinese ADRs? When do we flip it and start shorting?

    By the way, did you mean to spell it “Pyschology” on the top of the explorer bar? Pyschology- Behavioral Finance is a cool theme and perspective… looking forward to see how you run this blogsite!
    Thanks,
    -gio

  2. Market Speculator on July 5th, 2007 8:51 am

    Hi Gio,

    Thank you for the correction in spelling. I’ll do my best to minimize those.

    As for the Chinese markets I don’t think we’ll see an immediate impact. The ADRs will more than likely feel the pressure today from the drop. I must caution you, the most recent slide is on extremely light volume. I don’t have today’s figure just yet for volume but will post when I do.

    Thank you for the well wishes! I am hoping to add graphics and what not as I move along with this site.

    Cheers!
    MS

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