How Negative Trading Psychology Lowers Returns
Guest post by Susan Porter. Many traders in today’s investment marketplace have negative psychological traits that can work against them. As prevalent as these traits can be, traders may not even be aware of how such negative traits can prevent them from making bigger returns.
Negative psychology is rooted in cognitive biases, or behavior patterns that distort judgment. Almost everyone experiences these biases, and in economic market situations, they can frequently be a hindrance. They may create a negativity that limits rational evaluation, or causes us to believe we have unlimited rationality. Because of this, economic and investment judgments are often less than rational. This leads to over confidence in investments or panic when one is doing poorly. It also leads directly to something that’s a key part of human behavior both in and out of the economic marketplace: loss aversion.
In fact, our aversion to loss is so strong that we believe we have control over our own behavior, when frequently we have no control either externally or as self-control. Our lack of self-control shows up in trading terms when traders reveal a tendency to overstate their resistance to temptation.
Selfishness, too, is a negative psychological trait, that can cause overestimating or underestimating of either value or risk of an investment.
Big returns on investments can be limited by loss aversion, selfishness and many other negative psychological traits that a trader – like any human being – can exhibit. There are cognitive biases in a number of areas that effect a trader’s actions and returns.
One common bias is the ambiguity effect, which causes one to avoid options that include missing information – thus a trader won’t invest when the probability of return is at least apparently not known. Another is the tendency to anchor, or rely heavily on a piece of information utilized in the past. Clinging to past marketplace evaluation is a sure fire negative for big returns, given the volatility of the marketplace.
A trader who exhibits a behavioral backfire effect will react to what should be new, altering information by instead strengthening their own existing beliefs.
The FB IPO
While the world is getting prepared for the FB hype, let’s review the pros vs cons of the stock.
Video below, courtesy Omid Malekan.
HFT: A Clear and Present Danger
The Trader has written many posts over the year regarding HFT. With 47 000 quotes and no trades att all, this is getting ridiculous, but what are the possible dangers of this behavior? Another Flash Crash? Say after me “HFT provides real liquidity”….This is a must read by Nanex.
On April 24th, 2012 at 15:51:44, the number of quotes for a single second in one stock set a new record: 47,138. The stock, PSS World Medical (symbol PSSI), is inactively traded: only 1,992 trades (317,127 shares) traded the entire day.
This event represents a clear and present danger to market stability, and needs to be investigated immediately. Due to the way stocks are processed, many other stocks were affected by this event. Just one example: PSSI is processed by UQDF line 5 which processes all Nasdaq stocks with symbols between PC and SPZZZZ. That means all other symbols in that range were also affected by what happened in PSSI. Symbols like QCOM, QQQ and SIRI fall into this group. We see more instances of stocks with more than 10,000 quotes in a single second. If HFT blasted just 10 stocks from one exchange at this rate, our national quotation system would collapse. The same thing would happen if this HFT blasted just a few stocks at this rate from all 10 exchanges — and we are detecting signs that this is occurring, though for now, at much lower rates.
We aren’t calling for a 5 alarm fire just yet, but there is smoke in the air and dry tinder everywhere.
Dax lost the outperformance?
The DAX has been the stealth performer over the past year. With the Med countries falling into the abyss, the stabile German index has been the absolute outperformer in Europe. The DAX outperformance has been “cooling” off lately though.
Let’s see if the extreme spread starts reversing some going forward.
Charts below.
The four totally bad bears
Guest post by Doug Short.
This chart series features an overlay of the Four Bad Bears in U.S. history since the market peak in 1929. They are:
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The series includes four versions of the overlay: nominal, real (inflation-adjusted), total-return with dividends reinvested, and real total-return.
The first chart shows the price, excluding dividends for these four historic declines and their aftermath. We are now at 1143 market days from the 2007 peak in the S&P 500. In nominal terms (not adjusting for inflation) over the same elapsed time, the current market is our top performer, 12.7% below its peak. The 1973 Oil Embargo bear is in second at -14.1% with the post-Tech Bubble in third place at -27.1%. The crash of 1929 fared far worse at -65.2%.
Inside story of the Global Financial Crisis
Toxic assets, derivatives, mispricing of risk, Bear Sterns, Lehman Brothers and much more.
Simply must watch video by Frontline.
Money, Power and Wall Street.
Videos below.
A Brief History of Apple Earnings, in Pictures
Guest post by Vix and more.
If a picture is worth a thousand words, then perhaps I can save quite a few keystrokes and maybe even a few tweets with the compendium below.
This is a visual post, so I will keep my comments brief, except to note that the graphics below originate from LivevolPro.com and provide a graphical history of Apple (AAPL) earnings from July 2010 to the present.
Each column represents one earnings reporting cycle and includes three charts and four earnings periods:
- Top candlestick chart shows eleven days of AAPL stock prices, with five days before and after the earnings report
- Middle chart shows the prices of straddles in the front month and second month for AAPL options (useful for determining the degree to which investors under or overestimated the post-earnings price move)
- Bottom chart shows 30-day implied volatility derived from the front month and second month AAPL options (similar to what is now available from VXAPL)
Remember that you don’t have to have an option about Apple’s earnings report, but since everyone else does and the markets have one priced in, it may be helpful to put the current situation into historical context.
You can’t beat Apple, “they” are killing it
The N01 stock in the world did it again. Apple beating earnings is nothing new, but the extreme volatility we have seen in the stock should make investors somewhat more alert. Let’s see how Apple trades in the coming weeks, but the volatility must decrease, or those hedge funds all long Apple better start exiting some of their positions. More from Bloomberg below.
News That Matters
All you need to read and more below.
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