Lecture 6 Flashcards
(22 cards)
Are people rational?
Biases and blind spots
People don’t even realize they are being bias
Is all information available?
Yes, the internet has a ton of information - but also lots of bad information
- Efficient market hypothesis requires it as an assumption
However, some people still have insights that aren’t readily available
Are assets properly priced?
Usually, but not always which is why people can make money.
It’s hard to find the underpriced assets
Can people outperform the market?
Sure, Warren Buffet is a great example
No one would work in this industry if you didn’t believe you could
Are there trends or is everything random?
Efficient Market Hypothesis (EMH) - Random
Technical analysis - Trends
EMH
Maurice Kendall says no - there are no trends. Which led to EMH being developed.
Supported over long term
All info is available and quickly disseminated
People are rational, utility maximizers and risk averse
Market price = intrinsic (assets are properly priced)
Impossible to outperform the market
Intrinsic Value - What a stock is REALLY worth, with data
Market price - What someone is willing to pay for something (Tesla example)
EMH disagrees with Fundamental or Technical
EMH believes in Random Walk
The past means nothing
There is no trend in my walk
Technical looks at the past in order to determine the future
Fundamental looks at the stock as a whole (management, financials, etc)
Weak
Random walk - no past events can influence prices (they are random) - no info is reflected in stock because it doesn’t change it
Semi Strong
All public info is reflected in stock - no private
Event test, time series, regression test
Strong
All public and private are reflected
Impossible to outperform
ETFs - Exchange Traded Funds
Replicates or invests in an index
If you believe in EMH then you should buy ETFs
Can be passive or active
Passive - Reflect index at beta of 1 (or as close)
Active - use the index but make some calls, willing to bring up or down the beta
Focused on portfolio construction
Try to find the cheapest fees ETFs
Behavioural Finance versus traditional finance
People are humans, not computers
We all evaluate things differently (risk, reward, preferences, etc)
People have bias
About stocks because people should not be emotionally involved in stocks
Traditional finance assumes people are unbiased, rational, etc
Bounded Rationality
People aren’t emotional, they just don’t have all the information (do the best you can with the knowledge you have)
Prospect Theory
Descriptive theory of decision making in risky situations
How you frame a question or statement will change someone’s feelings about it
People can be manipulated
How do you evaluate risk?
- How you say something to someone changes their perspective of risk and reward
Cognitive Errors
Hindsight - Past events predictable
Anchoring & Adjustments - Heuristics
Mental Accounting - Buckets - Casino example pockets
Framing - depends on presentation (questions)
Availability - Answer related to familiarity
Emotional Biases
Overconfidence - over trading or over waiting or over buying
Loss aversion / Regret Aversion - Avoid things that they might regret later
Self-Control - short term vs long term - time horizon (Richard Thaler)
Status Quo - Laziness, people prefer to stay comfortable - pension automatic enrollment - get people doing something that becomes a habit
Endowment - Because you own it, its now better then before
Technical Analysis
The trend is your friend
Common tool used by traders
Disagree with EMH
Agree with Behavioural Economists
Behaviour can feed into trends
- Disposition effect (momentum)
- Overconfidence (bubble)
- Mental accounting (new highs or lows)
- Conservatism (momentum or herd)
- Sentiment (use of Vix or consumer confidence)
Support and Resistance
Breaking resistance - Reverse head and shoulders - Bullish sign
Breaking support - Head and shoulders - Bearish sign
Moving Average
Moving Average - can be created for any segment of time
Smooths out the ups and downs to show a smooth line
Similar Trends
Market Breadth - Advances versus declines
Relative Strength - Stock compared to Industry - How is Honda doing in the auto market
Odd Lot Theory
If a stock is trending upwards, you should look at the size of transactions, if there are only small amounts being bought then it is probably by inexperienced and ill-informed investors (less than 100 shares)
Sentiment
Put/Call ratio tells you bulls vs bears
More puts - bear - make money when prices go down
More calls - bull - make money when prices go up
