Hank Pruden’s theory of "Behavioral Finance" proposes that human flaws are consistent, measurable and predictable, and being aware of and utilizing this phenomenon can benefit a trader.
"For the better part of 30 years, the discipline of finance has been under the thrall of the random walkcum efficient market hypothesis. Yet enough anomalies piled up in recent years to crack the dominance of the random walk. As a consequence, the popular press has been reporting the market behavior," said Pruden. One of these new methods discussed is "behavioral finance."
Pruden is a professor in the School of Business at Golden Gate University in San Francisco. He was a featured speaker at the 20th annual Telerate Seminars Technical Analysis Group Conference (TAG 20).
Behavioral finance is "the use of psychology, sociology and other behavioral theories to explain and predict financial markets. Behavioral finance describes the behavior of investors and money managers and their interaction in companies and securities markets. It recognizes the roles of varying attitudes toward risk-framing of information, cognitive errors, lack of self-control, regret in financial decision-making and the influence of mass or herd psychology," said Pruden.
Predictable human behavior can and does impact markets, said Pruden. One example is the "crowd psychology" or "bandwagon" theory. For example, if a market is coming up from a basing area on the charts, "smart money" is responsible for the majority of the initial buying. "As people jump on board, we see the bandwagon effect, and that bandwagon pushes prices up. Volume tends to surge at its peak, certainly on the buy side, during the mark-up phase in the middle. Later on, toward the end of the trend, smart money is not doing the buying; somebody else is. The smart money is doing the selling. The market tops by curving over, or sometimes with a spike top. So, we can see express that in price and we can see under it in volume," said Pruden.
Regarding the type of trading approach to the bandwagon effect, Pruden said, "We align our indicators to show a distribution pattern or a breaking of trendlines, and we should see a post-volume peak. Volume will typically peak before a big change in sentiment."
Pruden said he puts time, price and sentiment together to come up with a composite to look at all those parameters at once. This composite would help in any trading decision, he said.
In the four major elements of technical analysis - price, volume, time and sentiment - recognizing and factoring in human behavior is certainly a major portion of the sentiment element, said Pruden.
At Golden Gate University, Pruden developed and teaches accredited courses in technical market analysis.
The recent problems and the seeming implosion of the euro, is I suggest something, which I have come to the conclusion, is something, which has been looming and brewing up for some time – the past several years...
Last week I discussed Chapter 12 of the second edition of Trade Your Way to Financial Freedom, talking about how five investors with totally different ideas, including opposite views on what might happen, could all profit from various scenarios...
A main tenet of success in futures trading is the ability to accept losing trades as part of the overall trading process. This is not an easy undertaking--especially since many futures traders tend to be of a more competitive nature in the first place...
I was recently approached by a top hedge fund about profiling the best traders in the world. Profiling really refers to finding those psychological characteristics that will best predict success...
I have had many readers through the years--most of whom...
I have a pretty good taste in art, I think. At least, I can go into most art galleries...
One of my hobbies is playing poker and I can do it for free online. When I visit a casino and play poker, I usually make money. However, when I started to play online with play money, I had tremendous difficulty making money...
If you are a regular student of Van Tharp's work or reader of this newsletter you hear this a lot: You can't trade the markets, you can only trade your beliefs about the market. Let's explore what this really means...
|9||Fort Financial Services||66%|