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Behavioral Finance Theory and Crowd Psychology
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Behavioral Finance Theory and Crowd Psychology

  #21 (permalink)
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Private Banker View Post
I believe I've shared this site before but it's a great source for white papers discussing all the in's and out's of behavioral finance:

Behavioural Finance

Of course there's a ton of information out there regarding this topic but my thoughts are to fade the herd as much as possible. Look to create or be a part of a new trend vs. following one. For example, if everyone is buying into a certain market, you should be selling to them as you scale out of your position. When the frenzy stops and they're running for the exits, that's when it's time to start buying again.

But what's interesting about behavioral finance is all the underlying categories in which, we as traders, deal with on a daily basis. To own control of this is key to trading/investing success in my opinion. I've studied great lengths of this topic in the past and it has helped me tremendously in managing money for clients (in the past) and for myself.

According to Mr. Rothschild, the time to buy is when there's blood in the streets and every one is panicked. It flies in the face of what the typical trader/investor tries to do.....and I think they would if they had the capital to hold the trade while it was underwater and the stomach to ride it out.......

As a retail trader, I don't have the capital to create a new trend, therefore, I feel I must get on board one created by those larger than myself and ride that one....trying all the time to anticipate when the wave is over....dicey business to be sure.

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  #22 (permalink)
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PandaWarrior View Post
According to Mr. Rothschild, the time to buy is when there's blood in the streets and every one is panicked. It flies in the face of what the typical trader/investor tries to do.....and I think they would if they had the capital to hold the trade while it was underwater and the stomach to ride it out.......

As a retail trader, I don't have the capital to create a new trend, therefore, I feel I must get on board one created by those larger than myself and ride that one....trying all the time to anticipate when the wave is over....dicey business to be sure.

Not as much as you might think. It's a question of pattern recognition to identify initiating activity and stopping volume. Both of these patterns give some clues where this might occur.
  • A large increase in volume which initiates a bullish price move, will identify an area of potential support should price return to this area. (initiating volume)
  • A large increase in volume which initiates a bearish price move, will identify an area of potential resistance should price return to this area. (initiating volume)
  • A large increase in volume which stops a bullish price move, will identify an area of potential resistance should price return to this area (stopping volume)
  • A large increase in volume which stops a bearish price move, will identify an area of potential support should price return to this area (stopping volume)
Source: clickme

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  #23 (permalink)
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Fat Tails View Post
A thread on "Behavioural Finance Theory and Crowd Psychology" is probably a bit too much for this forum.

Oh come on, where is your sense of adventure? Surely a discussion on behavioral finance is more interesting than adding alerts and colors to indicators

Mike

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  #24 (permalink)
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Private Banker View Post
I believe I've shared this site before but it's a great source for white papers discussing all the in's and out's of behavioral finance:

Behavioural Finance

Of course there's a ton of information out there regarding this topic but my thoughts are to fade the herd as much as possible. Look to create or be a part of a new trend vs. following one. For example, if everyone is buying into a certain market, you should be selling to them as you scale out of your position. When the frenzy stops and they're running for the exits, that's when it's time to start buying again.

But what's interesting about behavioral finance is all the underlying categories in which, we as traders, deal with on a daily basis. To own control of this is key to trading/investing success in my opinion. I've studied great lengths of this topic in the past and it has helped me tremendously in managing money for clients (in the past) and for myself.

Thanks Ben.

So let me ask a few questions, to stimulate debate:

a) If we want to fade the herd, or do the opposite of the herd, then you are saying that it is the minority who is moving the market directionally?

b) Be part of a new trend, vs following the existing one: So are you saying that once a trend is established or defined enough to be "well known" by the herd, that you should look to stop trading it, and instead patiently wait for the reversal or new trend before putting on a position?

c) You want to sell to the buyers, and buy from the sellers: you need to be a couple of steps ahead of the crowd/herd in order to achieve this. So does this mean you are taking bigger risks? Bigger positions? More scaling? Does this mean you are wrong far more often than you are right, as you are trading primarily at extremes?

Again, I am asking to stimulate debate, I am not defining my position in the statements

Mike

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  #25 (permalink)
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Big Mike View Post
Oh come on, where is your sense of adventure? Surely a discussion on behavioral finance is more interesting than adding alerts and colors to indicators

Mike

I love those colors and alerts, they are my universe. It is more colourful and peaceful than crowd psychology.

Also I do not have a sense of adventure, because this would negatively affect my behaviour as a trader.

I am only posting here to compensate the boredom of trading.

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Fat Tails View Post
I am only posting here to compensate the boredom of trading.

I have some ideas for some more webinars you can present on, to help pass the time

Mike

Due to time constraints, please do not PM me if your question can be resolved or answered on the forum.

Need help?
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4) Accept responsibility for your actions. Stop looking elsewhere to explain away poor performance.
5) Where to start as a trader? Watch this webinar and read this thread for hundreds of questions and answers.
6)
Help using the forum? Watch this video to learn general tips on using the site.

If you want
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  #27 (permalink)
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You're welcome! I appreciate the questions.

Here are my thoughts to your questions:


Big Mike View Post
a) If we want to fade the herd, or do the opposite of the herd, then you are saying that it is the minority who is moving the market directionally?

This explanation is swing trade oriented but could certainly apply to intra-day trading as well. Markets are cyclical. There are periods of advances and declines. The key to being ahead of the "herd" is to be proficient at technical and sometimes fundamental analysis. With that being said, being proficient in those areas, one will be able to begin establishing a position in a market while the herd is trying to get out and away. Actual position sizing will vary dependent upon risk tolerance. But in a scenario such as this, you would most likely start building a small core position and adding to it at key levels. Markets move in stages and you want to dip your toes in at the beginning of a new move, adding to it upon confirmation and when the move begins to "mature" you'll want to start to sell your position and take off risk as the move is maturing more and more. You would then be selling your positions to the "Joe Sunday's" that just talked to their broker about how the "market" is going up. Then his friends are getting in and CNBS starts talking about the rally. At that point, you'll want to have scaled significantly and just manage a small position to milk the remainder of the move.

The transition begins when exuberance is through the roof and your selling becomes a net short based on what is happening technically in the market vs. being previously net long.

So to answer your question, it's not a case of a minority few controlling the market, it's a case of timing the cruise ship as it's making it's turn. Not everyone buys and sells at the same time which is why we see markets go through stages. A hedge fund may have an idea about a market and start establishing a position which then creates a signal for a technical trader that joins in the action, then volume starts rising bringing in more to the party. Once this is noticed by the general public the hedge fund manager is selling his positions to the late comers and simply managing the remainder of his risk while looking for other markets to do the same thing with.


Big Mike View Post
b) Be part of a new trend, vs following the existing one: So are you saying that once a trend is established or defined enough to be "well known" by the herd, that you should look to stop trading it, and instead patiently wait for the reversal or new trend before putting on a position?

I would say at this point you should have scaled out a majority of your position and just have a trailing position on which will be your accumulated gains. You would then hold on to that until you begin to either see this market fade out or one of your other positions in another market is beginning to work and you dedicate your capital to that market. Once a move is well known by the herd, it's likely that it will end soon. The current case with equities is a direct result of the world's central banks propping up the markets by providing trillions of liquidity into the market. As we know, this is not sustainable and will eventually hurt the herd once again.


Big Mike View Post
c) You want to sell to the buyers, and buy from the sellers: you need to be a couple of steps ahead of the crowd/herd in order to achieve this. So does this mean you are taking bigger risks? Bigger positions? More scaling? Does this mean you are wrong far more often than you are right, as you are trading primarily at extremes?

I kind've went into this in my last answer but yes, that is precisely what you want to be doing. A small position would be established to test the trade thesis and control your initial risk. So, you could say you would be trading the extremes or high volume churn areas. As the trade begins to confirm your idea, you begin to add at key levels. Trades like this should have initial targets just like intra-day trades which allow you to take risk off and capture gains. Modern portfolio theory suggests that you take money out of high performing assets classes and invest them into assets classes that have not yet began a move. This is essentially what you're doing here.

Position sizing would be again at the discretion of the investor/trader based on their risk tolerance and account equity. You could theoretically initiate a trade with 1 contract and add to it as the move advances in your favor. You would then add to your position with the house's money. This can go on as long as the move still makes sense and is relatively immature in it's stage. Then once an initial target is reached, begin to scale out from there. Eventually, you're remaining position will just be built up gains that you would continue to manage until the move begins to fade and the herd comes running in and tips the boat.

Anyway, hopefully that all made sense and wasn't too repetitive. I can expand further on anything I mentioned here.


Last edited by Private Banker; April 11th, 2012 at 09:24 PM. Reason: Typo
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  #28 (permalink)
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PandaWarrior View Post
According to Mr. Rothschild, the time to buy is when there's blood in the streets and every one is panicked. It flies in the face of what the typical trader/investor tries to do.....and I think they would if they had the capital to hold the trade while it was underwater and the stomach to ride it out.......

As a retail trader, I don't have the capital to create a new trend, therefore, I feel I must get on board one created by those larger than myself and ride that one....trying all the time to anticipate when the wave is over....dicey business to be sure.

Good points. My thought here with regards to being in a trend vs. starting one or being a part of a new one is being able to think and trade like those that are starting the trend. With regards to intra-day trading, just about every entry I take in Crude Oil, begins with some heat. It doesn't mean I'm wrong however if the market goes 15 ticks against me, it just means that the market needs some room to figure out it's about to turn around. My stops are then placed at areas where I know I truly am wrong and I let the market take me out. You never know 100% obviously which is why I'm willing to just sit and watch. But the idea is to get in at areas of importance and let the big boys eat up all the other traders while you manage your smaller position appropriately such as scaling out and controlling risk.

So in essence, you aren't "creating the trend" but you're knowledgeable enough to get in at the areas where the trend makers are and are taking advantage of all the other traders who aren't seeing what you're seeing.

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How Market Psychology Drives Technical Indicators

http://www.nber.org/papers/w10203.pdf


http://arxiv.org/pdf/1112.1051.pdf

"Successful trading is one long journey, not a destination" Peter Borish Former Head of Research for Paul Tudor Jones speaking on conversations with John F. Carter

Last edited by GridKing; April 11th, 2012 at 10:21 PM.
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New Online course on Behavioral Econ


https://www.coursera.org/course/behavioralecon

Dan Ariely is teaching it. Hard to say whether it will be too applicable to trading but will likely be a very interesting course...

Seek freedom and become captive of your desires. Seek discipline and find your liberty. - Frank Herbert
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