Remember Smith’s invisible hand? The market, Smith said, represents the collective efforts of all people to maximize their own wealth. If people are all acting independently of one another, it’s possible that their collective behavior is truly random. But what if they’re reacting to each other?
Under that scenario, their collective behavior one day may impact the collective behavior the next day. That is, the market will have memory. Just as a sports commentator might say that LeBron James has a ‘hot hand’ after he makes a series of consecutive baskets, the movement of a particular stock in one direction might lead some analysts to conclude that a pattern has emerged.
On the other side of the fence, you’ll have observers of that same pattern who argue that the price movement is shear chance. There are thousands of stocks trading on the world’s markets, surely one of them will occasionally “break out,” even if the market is, in fact, totally random.
How do we discover who is right? In The Art of Strategy, Avinish Dixit and Barry Nalebuff describe one approach to this problem:
Psychology professors Thomas Gilovich, Robert Vallone, and Amos Tversky…look at all the instances of a player’s baskets and observe the percentage of times that player’s next shot is also a basket. A similar calculation is made for the shots immediately following misses. If a basket is more likely to follow a basket than to follow a miss, then there really is something to the theory of the hot hand.
So we’re going to take this same simple analysis and apply it to a data set of 30 randomly selected stocks. We’ll pull our data from the price history database at Yahoo Finance and then we’ll look at how the stocks performed one month after the data set ends.
At the time of this writing, I don’t know what the outcome will be, but I have a hypothesis: my analysis will demonstrate that the market is not truly random, but the correlation and magnitude of the pattern will not be significant enough to constitute an actionable investment strategy. My hypothesis, in short, is that my finance professors were wrong when they told me that the market was efficient, but they were nonetheless right when they suggested that technical analysis is a waste of time.
Domestic Trends
:: Google paints a stark vision of the US economy.
Economic Analysis
:: Project Syndicate provides newspapers with analysis from the world’s top economists
Economic Calendar
:: The key events moving the market, highlighted by Briefing.com
Real Clear Markets
:: Daily briefing on the markets
Undervalued stocks
:: Stock screen based on “Warren Buffett and the Interpretation of Financial Statements”
Value Cruncher
:: A web tool that simplifies discounted cash flow analysis of public companies
Wikinvest
:: Simple research and portfolio consolidation.
Confessions of a Day Trader, Part 2: The “Hot Hand” of the Stock Market
Remember Smith’s invisible hand? The market, Smith said, represents the collective efforts of all people to maximize their own wealth. If people are all acting independently of one another, it’s possible that their collective behavior is truly random. But what if they’re reacting to each other?
Under that scenario, their collective behavior one day may impact the collective behavior the next day. That is, the market will have memory. Just as a sports commentator might say that LeBron James has a ‘hot hand’ after he makes a series of consecutive baskets, the movement of a particular stock in one direction might lead some analysts to conclude that a pattern has emerged.
On the other side of the fence, you’ll have observers of that same pattern who argue that the price movement is shear chance. There are thousands of stocks trading on the world’s markets, surely one of them will occasionally “break out,” even if the market is, in fact, totally random.
How do we discover who is right? In The Art of Strategy, Avinish Dixit and Barry Nalebuff describe one approach to this problem:
So we’re going to take this same simple analysis and apply it to a data set of 30 randomly selected stocks. We’ll pull our data from the price history database at Yahoo Finance and then we’ll look at how the stocks performed one month after the data set ends.
At the time of this writing, I don’t know what the outcome will be, but I have a hypothesis: my analysis will demonstrate that the market is not truly random, but the correlation and magnitude of the pattern will not be significant enough to constitute an actionable investment strategy. My hypothesis, in short, is that my finance professors were wrong when they told me that the market was efficient, but they were nonetheless right when they suggested that technical analysis is a waste of time.