Wednesday, 18 April 2012

Trade with your head, not with your heart


JOHN MANGUN
OUTSIDE THE BOX  
Business Mirror
http://www.businessmirror.com.ph/home/opinion/25909-trade-with-your-head-not-with-your-heart

ONE of the topics in my stock-market seminars is the psychology of stock- price movement. That is that prices are driven higher or lower by what is going on in the hearts and minds of the investors.

While we would like to believe that prices are moved in a logical and sensible manner based on all those neat financial numbers that companies report, ultimately it is an emotional human that pushes the buy or sell button. You are, of course, going to remind me that all those expert institutional funds use complex and complicated computer programs and formulas to trade the market. Yes and no.

While it is true that this “black box” trading does dominate the Western markets, it is also true that black boxes  are not all programmed to make the same decisions based on the same information. Otherwise, every black box would be buying on one day and selling on the next. And non-humans do not trade to any large degree on the Philippine stock market.

A 20-year study of the New York stock market made in the 1960s and 1970s showed that stock prices tended to fall, outside the possibility of random chance, on days that the weather was gloomy in New York City. Nice weather did not move prices higher but bad weather sent prices down.

In 1926 Prof. George Taylor from the University of Pennsylvania came up with the “Hemline Index.” Taylor was able to draw an almost direct correlation between the length of women’s skirts to economic and stock-market performance. The shorter the skirt, the higher the stock market. The mini-skirt became fashionable in 1965. In 1965 the Dow Jones index was at 995 and by 1975 the index had fallen to 577. So had women’s hemlines. From the sexy and skimpy fashions of the Roaring 1920s, by 1932 women’s dresses were back to touching the floor.

It makes sense to me. When your mood is good and you are ready to party, your partying probably includes buying stocks.

If you accept the concept that investors make emotional and intellectual judgments when trading the market and that those decisions move prices, then measuring the investor mood is a way to plot the direction of stock prices. And we technical analysts believe that price movement reflects investor psychology. Further, this analysis can pick up the mood swings that will change the direction of prices.

The markets are made from the hearts and minds of thousands of individuals who tend to generally move in one direction or another depending on the overall prevailing psychological attitude. But the key here is “individuals.” While your psychology has an effect on stock prices, what we sometimes forget is that in our own trading, we are all the psychology that goes into the decision.

Whether you make 20 transactions a day or one a month, we all face the “Empathy Gap.” The “gap” is when your intellect is overrun by your emotions. It is a psychological situation that affects your trading in two ways that you need to be alert to.

The British are big “bettors,” gambling on everything from sports to celebrity marriages. A study showed that having a fight with your spouse and then going to the betting parlor increased losses. Your frame of mind when you place a bet or a stock trade affects the results. I have this posted next to my computers where I trade. “Be aware of yourself and your surroundings. The market will be aware of you. Your market performance will improve.”

The second way the Empathy Gap can cost us money is when we let emotions change a decision we made with our heads. “I will buy this stock when it breaks out of its range on heavy volume.” And when that time comes, you don’t buy it, because the stock jumps 5 percent the minute it breaks out. You wanted to pay P50 and at P52 it suddenly seems expensive. Then you watch it go to P60.

Or this example. “I am not going to chase that issue. The Risk/Reward is not favorable.” Yet you still buy it because everyone you know is telling you how much money they are making with it.

Gamblers play their game using emotions. Investors do their business of trading the market with their brains.

On a personal note, my “Your Money: Preservation and Profits” stock-trading seminar will be April 28th in Makati. I guarantee you will find it beneficial, new trader or experienced. Reservations are strictly limited and must be made absolutely no later than this Thursday, April 19th. E-mail me at john@mangunonmarkets.com for details. In this kind of a market, you will be very glad you attended.




E-mail to mangun@gmail.com, Facebook page is MangunOnMarkets, and Twitter @mangunonmarkets. PSE stock-market information and technical analysis tools provided by CitisecOnline.com Inc.


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