Behavioural Technical Analysis: An introduction to behavioural finance and its role in technical ana
After all, rational shortcomings ought to provide plenty of profitable opportunities for wise investors. In practice, however, few if any value investors are deploying behavioral principles to sort out which cheap stocks actually offer returns that can be taken to the bank. The impact of behavioral finance research still remains greater in academia than in practical money management. While it points to numerous rational shortcomings, the field offers little in the way of solutions that make money from market manias.
Robert Shiller, author of "Irrational Exuberance" , showed that in the late s, the market was in the thick of a bubble. But he couldn't say when it would pop.
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Similarly, today's behaviorists can't tell us when the market has hit bottom. They can, however, describe what it might look like. Conclusion The behavioralists have yet to come up with a coherent model that actually predicts the future rather than merely explains, with the benefit of hindsight, what the market did in the past.
The big lesson is that theory doesn't tell people how to beat the market. Instead, it tells us that psychology causes market prices and fundamental values to diverge for a long time.
Technicians employ many methods, tools and techniques as well, one of which is the use of charts. A survey of modern studies by Park and Irwin [70] showed that most found a positive result from technical analysis. Since the early s when the first practically usable types emerged, artificial neural networks ANNs have rapidly grown in popularity. Depending on whether a company is considered by its separate assets and debts or as an interdependent complex, the analysis methods are subdivided into separate evaluation and overall evaluation methods Dehmel and Hommel They can, however, describe what it might look like. They then considered eight major three-day candlestick reversal patterns in a non-parametric manner and defined the patterns as a set of inequalities.
Behavioral finance offers no investment miracles, but perhaps it can help investors train themselves how to be watchful of their behavior and, in turn, avoid mistakes that will decrease their personal wealth. To continue reading on behavior-based trading, see Trading Psychology: Behavioral Finance Tenets and Findings of Behavioral Finance This field of study argues that people are not nearly as rational as traditional finance theory makes out.
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One of the problems with conventional technical analysis has been the difficulty of specifying the patterns in a manner that permits objective testing. Japanese candlestick patterns involve patterns of a few days that are within an uptrend or downtrend. Caginalp and Laurent [65] were the first to perform a successful large scale test of patterns. A mathematically precise set of criteria were tested by first using a definition of a short term trend by smoothing the data and allowing for one deviation in the smoothed trend.
They then considered eight major three-day candlestick reversal patterns in a non-parametric manner and defined the patterns as a set of inequalities. Among the most basic ideas of conventional technical analysis is that a trend, once established, tends to continue. However, testing for this trend has often led researchers to conclude that stocks are a random walk. One study, performed by Poterba and Summers, [66] found a small trend effect that was too small to be of trading value.
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As Fisher Black noted, [67] "noise" in trading price data makes it difficult to test hypotheses. One method for avoiding this noise was discovered in by Caginalp and Constantine [68] who used a ratio of two essentially identical closed-end funds to eliminate any changes in valuation. A closed-end fund unlike an open-end fund trades independently of its net asset value and its shares cannot be redeemed, but only traded among investors as any other stock on the exchanges.
In this study, the authors found that the best estimate of tomorrow's price is not yesterday's price as the efficient-market hypothesis would indicate , nor is it the pure momentum price namely, the same relative price change from yesterday to today continues from today to tomorrow. But rather it is almost exactly halfway between the two. Starting from the characterization of the past time evolution of market prices in terms of price velocity and price acceleration, an attempt towards a general framework for technical analysis has been developed, with the goal of establishing a principled classification of the possible patterns characterizing the deviation or defects from the random walk market state and its time translational invariant properties.
Trend-following and contrarian patterns are found to coexist and depend on the dimensionless time horizon. Using a renormalisation group approach, the probabilistic based scenario approach exhibits statistically signifificant predictive power in essentially all tested market phases. A survey of modern studies by Park and Irwin [70] showed that most found a positive result from technical analysis.
In , Caginalp and DeSantis [71] have used large data sets of closed-end funds, where comparison with valuation is possible, in order to determine quantitatively whether key aspects of technical analysis such as trend and resistance have scientific validity. Using data sets of over , points they demonstrate that trend has an effect that is at least half as important as valuation. The effects of volume and volatility, which are smaller, are also evident and statistically significant. An important aspect of their work involves the nonlinear effect of trend. Positive trends that occur within approximately 3.
For stronger uptrends, there is a negative effect on returns, suggesting that profit taking occurs as the magnitude of the uptrend increases. For downtrends the situation is similar except that the "buying on dips" does not take place until the downtrend is a 4. These methods can be used to examine investor behavior and compare the underlying strategies among different asset classes. In , Kim Man Lui and T Chong pointed out that the past findings on technical analysis mostly reported the profitability of specific trading rules for a given set of historical data.
These past studies had not taken the human trader into consideration as no real-world trader would mechanically adopt signals from any technical analysis method. Therefore, to unveil the truth of technical analysis, we should get back to understand the performance between experienced and novice traders. If the market really walks randomly, there will be no difference between these two kinds of traders. However, it is found by experiment that traders who are more knowledgeable on technical analysis significantly outperform those who are less knowledgeable.
Until the mids, tape reading was a popular form of technical analysis. It consisted of reading market information such as price, volume, order size, and so on from a paper strip which ran through a machine called a stock ticker. Market data was sent to brokerage houses and to the homes and offices of the most active speculators. This system fell into disuse with the advent of electronic information panels in the late 60's, and later computers, which allow for the easy preparation of charts. Another form of technical analysis used so far was via interpretation of stock market data contained in quotation boards, that in the times before electronic screens , were huge chalkboards located in the stock exchanges, with data of the main financial assets listed on exchanges for analysis of their movements.
This analysis tool was used both, on the spot, mainly by market professionals for day trading and scalping , as well as by general public through the printed versions in newspapers showing the data of the negotiations of the previous day, for swing and position trades. Despite to continue appearing in print in newspapers, as well as computerized versions in some websites, analysis via quotation board is another form of technical analysis that has fallen into disuse by the majority.
From Wikipedia, the free encyclopedia. Foreign exchange Currency Exchange rate. Hugh 13 January A Behavioral and Technical Analysis". An introduction to behavioural finance and its role in technical analysis. Lo; Jasmina Hasanhodzic The Evolution of Technical Analysis: Retrieved 8 August Japanese Candlestick Charting Techniques. Technical Analysis of the Financial Markets.
New York Institute of Finance, , pp. A Mathematician Plays the Stock Market. Getting Started in Technical Analysis. The Journal of Finance. Journal of International Money and Finance. The American Economic Review. Federal Reserve Bank of St. Technical Analysis Plain and Simple: Archived from the original on The Wall Street Journal Europe. The Journal of Finance, Vol. John Wiley and Sons, pages , , Journal of Behavioral Finance. Jandik, and Gershon Mandelker Advice from Industry Leaders , ed. Burton Malkiel Talks the Random Walk. Journal of Technical Analysis.
Summers, "Mean reversion in stock prices: Evidence and Implications," Journal of Financial Economics 22, , Journal of Finance Constantine, "Statistical inference and modeling of momentum in stock prices," Applied Mathematical Finance 2, , Irwin, "The Profitability of Technical Analysis: DeSantis, "Nonlinearity in the dynamics of financial markets," Nonlinear Analysis: Real World Applications, 12 2 , , Experimental Evidence" Economics Bulletin. Reminiscences of a Stock Operator: The discounted cash flow approach is differentiated by three methods: The WACC method is based on the assumption that the company is first evaluated under the point of view of all providers of capital — equity as well as debts Bruns and Steiner Therefore, the cash flow is expressed by the Free Cash Flow FCF , which still contains the cash flows obtained by creditors Deter et al.
The free cash flows are discounted by the WACC, which expresses the expected return of shareholders as well as creditors Copeland et al. The WACC is calculated by the formula: The sum of WACC-discounted free cash flows and residual value expresses the value of the company under the point of view of both, the shareholders and the creditors. Therefore, the value of debts has to be subtracted afterwards to ensure that the value of equity of the company remains Deter et al. In order to achieve the value of equity, the sum of CAPM-discounted free cash flows and residual value, as well as the value of the tax shield, are subtracted by the value of debts at the end.
In comparison to the WACC method, the APV has the advantage of generating transparency in terms of the respective value drivers of the company Steiner and Wallmeier In contrast to the entity methods, the equity method only considers the cash flows obtained by the shareholders — the so called Flows to Equity FTE.
In analogy to the applied cash flow definition, the flows to equity are only discounted by the expected return of the shareholders i CAPM in a first step. In a second step, the residual value of the company RV is determined and also discounted by the expected return of the shareholders Vettiger and Volkart With regards to the advantages and disadvantages of the discounted cash flow concept as a whole, the following conclusions can be determined:.
Unlike balance-sheet driven success figures, cash-flows are less susceptible to manipulations Behringer , Deter et al a.
This explains its superiority in comparison to its most similar evaluation method — the capitalized earnings value approach. On the other hand, the estimation of future cash flows can be complex in practice, due to the large number of influencing factors on the estimated cash flow Damodaran The application of market multiples is based on the premise, that the value of a company can be derived by comparing a predefined performance figure of the evaluated company with the value of that performance figure of a comparable company Coenenberg and Schultze Therefore, the formula for calculating the fair value of the evaluated company is illustration not visible in this excerpt.
An Introduction To Behavioral Finance
The multiple can refer to profit-orientated, earnings-orientated e. The multiple is determined by the comparative company approach, which is differentiated by its three sub-methods, differing in terms of its derivation methods of the multiple:. The recent acquisition method derives the multiple from recently executed transactions, whereas the initial public offering approach calculates the multiple based on recently paid prices for companies that have gone public Dehmel and Hommel In contrast to that, the similar public company method takes each comparable publicly-quoted company into consideration Bausch Otherwise, the expressiveness of the used multiple has to be severely challenged.
In addition to that, there are some other arguments that put the concept of multiples into question: In hindsight, this was the case during the new economy phase at the end of the 20th century Perkins and Perkins , where the heavy use of market multiples at least supported the process of wrong stock pricing Hoffmann , due to the fact that the peer group itself was wrongly priced by the market. Furthermore, multiples belong to the group of static analysis concepts, meaning that future growth rates are not taken into consideration Deter et al. That could have a serious impact on the comparability of companies if the considered companies clearly differ in their predicted future growth rates Dehmel and Hommel Taking these aspects into consideration, the IDW advises that the concept of multiples should only be used for checking the plausibility of results of other more detailed and dynamic concepts, such as the discounted cash flow or the capitalized earnings value approach Aders et al.
This is particularly due to the fact that multiples are persuasive in terms of a simple, fast and inexpensive application for determining at least a broad price range for a potentially fair value of a company Deter et al. Brown and Reilly , p. This leads to the conclusion that present value concepts are based on the assumption of a symmetrically distributed future company value, whereas the concept of real options is based on an asymmetrical distribution assumption Allen et al. Unlike real options, present value concepts therefore underestimate the value of a company Antikarov et al Autocorrelation and spectral tests on chosen stock indices prove the random walk hypothesis to be incorrect Granger and Morgenstern Autocorrelation tests on the New York Stock Exchange reject the random walk hypothesis Kinney and Rozeff and the assumption of normal distribution Fiellitz and Greene Bertoneche analyzes six European stock markets and draws the conclusion, that the application of filter techniques is able to beat a simple buy-and-hold strategy.
Berry and Howe show that stock market prices react in a biased and late manner to new fundamental information. Economics - Case Scenarios.
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Register or log in. Our newsletter keeps you up to date with all new papers in your subjects. Request a new password via email. Actual Prices versus Intrinsic Values Figure Information Perception Anomalies Table 3: Information Treatment Anomalies Table 4: Decision Making Anomalies Table 5: Stock Market Anomalies Table 6: Introduction During the last eleven months, the stock market has been characterized by crashes and a historically high volatility.
The newspaper headlines around the world documented the extent of the stock market decrease and this historically high volatility: Taking the turbulent stock market phases as well as these unanswered questions about fundamental analysis, behavioral finance and the technical analysis into consideration, this thesis ultimately pursues two general objectives: Efficiency Forms According to Roberts, Fama classified the concept of information efficiency in three different forms of efficiency Sapusek Classification of Fundamental Analysis, Behavioral Finance and Technical Analysis The distinction between the three forms of information efficiency is particularly important in terms of the applicability of the three analysis concepts — fundamental analysis, behavioral finance and technical analysis — which differ in their assumptions of their underlying information efficiency form Sapusek Empirical Studies During recent decades, the EMH has been widely analyzed on stock markets — qualitatively as well as quantitatively — following the objective of being able to draw a conclusion whether or not the EMH is present.
The most important analysis tools and their respective analysis results are listed in the following: So, which of the three efficiency forms exists on the stock market? Company Evaluation Methods With regard to the different premises of the most important value drivers as well as different motives for evaluating a company Borowicz , fundamentally-driven analysis methods are differentiated by different methods and approaches, shown in Figure 1: Overview of the Different Company Evaluation Methods Coenenberg and Schultze Depending on whether a company is considered by its separate assets and debts or as an interdependent complex, the analysis methods are subdivided into separate evaluation and overall evaluation methods Dehmel and Hommel Separate Evaluation Methods The separate evaluation methods assume that the value of a company can be calculated by summing up the separately evaluated assets a , subtracted by the nominal sum of debts d of the company Deter et al.
Overall Evaluation Methods Unlike the separate evaluation methods, the overall evaluation methods evaluate a company as a whole, by taking the interdependencies between separate assets and debts into consideration Borowicz Present Value Methods Present value methods are based on the premises of the future-oriented capital budgeting approach Deter et al. Capitalized Earnings Value Approaches Capitalized earnings value approaches calculate the value of a company by discounting and capitalizing the future sustainable earnings of a company Borowicz The costs of equity are calculated by two steps: In comparison with the discounted cash flow approaches, the capitalized earnings approach has two disadvantages: Discounted Cash Flow Approaches Discounted cash flow approaches calculate the value of a company by discounting its future cash flows Borowicz With regards to the advantages and disadvantages of the discounted cash flow concept as a whole, the following conclusions can be determined: Market Multiples The application of market multiples is based on the premise, that the value of a company can be derived by comparing a predefined performance figure of the evaluated company with the value of that performance figure of a comparable company Coenenberg and Schultze Therefore, the formula for calculating the fair value of the evaluated company is illustration not visible in this excerpt Whereby: The multiple is determined by the comparative company approach, which is differentiated by its three sub-methods, differing in terms of its derivation methods of the multiple: The Three Methods of the Comparative Company Approach Dehmel and Homel The recent acquisition method derives the multiple from recently executed transactions, whereas the initial public offering approach calculates the multiple based on recently paid prices for companies that have gone public Dehmel and Hommel Can the theory of Behavioral Finance depict the reality on stock ma A Behavioral Finance research paper.
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