Investor psychology in Capital Market

DH review how psychological biases affect investor behavior and prices. Systematic mispricing probably causes substantial resource missallocation. DH argue that limited attention and overconfidence cause investor credulity about the strategic incentives of informed market participants. In financial economics, the most salient example is the efficient markets hypothesis. The efficient markets hypothesis reflects the important insight that securities prices are influenced by a powerful corrective force. If prices reflect public information poorly, then there is an opportunity for smart investors to trade profitably to exploit the mispricing.

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In recent years, some finance researchers have returned to such a broader conception of economics, and have denied market efficiency its presumption of innocence. This denial is based upon theoretical arguments that the arbitrage forces acting to improve informational efficiency are not omnipotent. 
 

Besides that, DH show how imperfect rationality affects trading, expectations and prices in capital market

1. Investor often do not participate in asset and security categories

A focus on what is salient may cause investors to invest only in stocks that are 'on their radar screens; Non-participation may also be related to familiarity or 'mere exposure's effects, e.g., a perception that what is familiar is more attractive and less risky

2. Investor use past performance as an indicator of future performance in mutual fund and stock purchase decision

3. Investor trade too aggressively

Volume is too large is hard to establish without benchmark rational level of volume. Rational dynamic hedging strategies, in principle, can generate enermous volume with moderate amount of news.

4. Investor do not always form efficient portfolios

Generally of course. Several experimental studies examined portfolio allocation when there are two risky assets and a risk-free asset and returns are distributed normally. People often invest in inefficient portfolios that violate two-fund separation, though trained MBA students do better :(

5. Certain classes of investor and their agents change their behaviors in parallel

This phenomenon, called herding, is consistent with rational responses to new information, agency problems or conformity biases. The tendency of analyst to follow the prevailing consensus is not stronger when that consensus proves to be correct than when it is wrong (Welch, 2000)

and many more...


Reference:
Daniel & Hirshleifer (DH)

well guys, often human is driven by their emotion... uncontrollable action that result the bad decision. there are many crazy people who want to be the winner, You should manage your emotion in stock market to eat them up.

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well, i recommend this book and i hope it can help you
1. The Psychology of Trading: Tools and Techniques for Minding the Markets


2. The Intelligent Investor (This is the Fisrt and The Best Book that i ever read in my life time)


it's your choice,
the more you read, the more you smart to face the market...

The Essence of Value Investing

Value investing is not a technique, it is a philosophy. It is a way of life. In fact, value investor approach what they do insider or outside the world of finance in the same way-taking certain criteria to make a decision, while demonstrating emotional discipline along the way. 

These patient thinkers tap all available resources to make a judgment call, but follow no one source. They do their own work. Value investor trust their abilities, their instincts, and their philosophy. Their investment style is an extension of their unwavering personalities.

The goal of value investor is quite simple: to buy solid businesses at exceptional price in order to achieve adequate after-tax returns over a long period. The mental model is as follows:

Good Business + Excellent Price = Adequate Return over Time

After investors do their homework on a company, an assessment of the firm’s value is done, and a reasonable price to pay for the business is determined. The key understanding here is that the most successful investors have  a framework and a way of approaching stocks. “It’s all simple,” says M. Price. “It’s not rocket science. It’s Wall Street that makes it complicated. What Max Heine and Warren Buffett (My Favorite Investor J ) did was to boil it all down to buying companies when their value was deeply discounted...” Price explains.

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The keys to investing, based on simple rules such as purchasing companies at a discount, are easy to understand. They have worked for a wide range of value investors, such as catalyst-driven investor like M.Price of Mutual Series and J.Greenblatt of Gotham Capital, or patient owners such as Warren Buffett of Berkshire Hathaway and J.Rogers of Arial Capital Management. These approaches are well documented, and surprisingly, are not complicated. Implementation, however, is not so simple. The balance between the art of investing, assessing a management team or identifying a good business, and the science of investing, figuring out what price to pay based on what the company is worth, can be difficult for some.

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Unfortunately, there seems to be many definitions of what comprises a “good” business, there are also numerous ways that investors can determine if ther are getting an excellent price for a company. Even among value investors, you will find difference in opinion on the relationship between business value and price. The objective is to make sure that your definitions of “good business” is consistent with your definition of an “excellent” price. 
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The price paid is only meaningful if it is relative to the business’ value. Fair value is destination, price and time help value investors determine if it is worthwhile for them to take that journey. The rewards must justify the risks taken. In a rational market environment, price and value share a delicate balances, as one dictates the degree of the other. They should never be separated.

Reference:

"The 5 keys to Value Investing" by J. Dennis Jean-Jacques

Sponsor
of course, i recommend you to read this book (if you don't mind :))
1. The Intelligent Investor: The Definitive Book on Value Investing. A Book of Practical Counsel (Revised Edition)
2. Value Investing: From Graham to Buffett and Beyond (Wiley Finance)
3. Applied Value Investing: The Practical Application of Benjamin Graham and Warren Buffett's Valuation Principles to Acquisitions, Catastrophe Pricing and Business Execution
4. Buffett Beyond Value: Why Warren Buffett Looks to Growth and Management When Investing

The more you smart, the more you trust by people...

Thematic Investment: Profiting from Disruption

What is Thematic Investing?

Thematic portfolios are structured to take advantage of the investment opportunities generated by investment themes. These are unifying ideas linking elements that might otherwise appaear unconnected, but which in time look set to become generally understood and accepted by investors, and so reflected in performance and valuations. Thematic investors seek to identify the winners and losers as themes disrupt established industry structures.

 

Most of themes are associated with long term patterns of change in broad-based areas that include technology, life sciences, economics, politics, demographics and the environment. Within these areas, managers select more narrowly defined trends whose economic implications are imperfectly understood by investor and therefore offer the opportunity for thematic portfolio investor to generate out-performance.

 

Some managers prefer to structure their portfolios in terms of broad business concept such as "innovation", "competitive advantage" or "restructuring", which they refer to as themes.

Does Thematic Investing Work?

In order to measure thematic returns - and compare them with those generated by traditional equity managers - we created an equally weighted composite performance stream for the largest multi-themed global thematic investment funds.

This type of analysis has certain limitations. By its very nature, it reflects the returns achieved by a wide range of different thematic management styles. The result are also affected by "survivorship bias", which arises when failed funds are either dropped from the analysis or not include initially, resulting in past returns being overestimated. 

 

What Drives Thematic Stock Selection?

Thematic investing can be effective mechanism for identifying stock opportunities because it uses a different frame of reference than that of most traditional equity services. all active portfolio managers set out to compare the attractiveness of a variety of investment opportunities. However, thematic portfolio managers look at markets from a different perspective and therefore may be able to uncover different alpha sources.

 

Next time i will continue sharing this topic, :)

Reference:

"Global Thematic Research" by Alliance Bernstein