Introduction to Behavioral Finance, Crowd

behavior and Technical Analysis

Session I
June, 2021

1
Introduction (Spending, Saving and Investing)

• Spending vs Saving:

– What is saving?

2
Introduction (Spending, Saving and Investing)

• Investment is the choice by the individual to risk his savings with the hope of future gain.

• Key words:

• Choice
• Risking (Risk)
• Savings/money (Investment)
• Investment asset
• Increase (Return)
• Future expectations (time)
• Value (asset)

3
Introduction (Investment vs Consumption Assets)

• What is the difference between investment assets and consumption assets?

4
 Introduction

• What is a market?

• A market, is a place where both buyers and sellers attend to

trade.

• Similar to any market, a stock market is a place where both

buyers and sellers attend to trade any tradable security.

5
Introduction: What is a market?

6
 What is a market (stock market)?

The buyers represent

Price of
stock XYZ Supply

the demand side

The sellers represent

Number of shares (in 000's)
Demand the supply side

7
 Introduction

• Who are the buyers (demand) & sellers (supply)?

They are fund managers, portfolio managers, brokers, traders, specialists,
investors….etc…

They are all human beings!

8
 Introduction

• What are the factors affecting the stock market?

Economic factors (macro and/or micro).

Political factors.

Social and ethical factors.

They all sum up to FEAR or GREED

9
 What are the factors affecting buyers & sellers?

• Reactions or sentiments of buyers and sellers

towards market information (factors)

• Hope
• Confidence
• Greed
• Uncertainty
• Fear
• Panic

10
 What are the factors affecting buyers & sellers?

• The buyers’ and sellers’ behavior in the market

is driven by the factors (information) they
receive.

• The buyers’ and sellers' behavior affect the

demand and supply of the market & is
ultimately reflected on the price chart.

11
 Introduction

• Why do people buy shares? • Why do people sell shares?

• How do they prefer to buy? • How do they prefer to sell?

• What makes them do otherwise? • What makes them do otherwise?

• The answer lies within their belief and expectation of the future

• This belief is greatly influenced by their collective minds

12
 Introduction

• Behavioral Finance (BF)

• Its the study of how psychology impact the behavior of investors

or even financial analysts

• The underlying assumption of BF is that:

i. Investors are not always rational

ii. Have limits to their self-control
iii. Are influenced by their own biases

• BF aims to explain why market participants make irrational systematic

mistakes, in contrast to the assumption of rational market participants.

• Especially since such irrational actions affect prices action, price returns,
and causes market inefficiencies and anomalies

13
 Introduction

• Behavioral Finance (BF)

• The foundations of behavioral finance can be traced back since the

1800s and 1900s

• Many books have been published represented cornerstones and

foundations to BF such as:

• Extraordinary Popular Delusions and the Madness of Crowds (Charles Makay)

• Confusion of the confused (Joseph De La Vega)
• The Crowd: A Study of the Popular Mind (Gustave Le Bon)
• Psychology of The Stock Market (Selden)

14
 Introduction

• Cognitive Biases:

• Overconfidence and optimism • Conservatism

• Self-attribution • Loss (or regret) aversion
• Hindsight • Herd Mentality
• Representativeness • Disposition effect
• Confirmation • Unconscious bias:
• Narrative fallacy • Priming
• Framing • Affinity
• Anchoring • Embodied Cognition

15
How the brain works
The human brain consists of

• The brain stem: which is

responsible for and is
concerned with instinctive
behavior patterns, biological
drives and compulsive
behavior.

• The limbic system: which is

responsible for the and
involver with the recreation
of external experiences and
with emotional activity
(related to group activity)

• The cerebral cortex; which

deals with the ability to be
aware of the thought process
itself and to anticipate the
future and recreate the past
(frontal lobes)

• Unfortunately when one part is functioning the others shut down!

16
Crowd psychology
• People have the tendency to belong to groups.

• What is a crowd:

• A Group of individuals placed in a common extreme situation (event), united by

a common characteristic and are trying to achieve a certain goal.

• Each and every individual in the crowd is considered as a member of that crowd
and abides by its rules.

• The crowd is created by the collective minds of its members. However, the
psychology of the crowd completely differs from the psychology of those
individuals within it.

• The summation of the minds of all individuals inside the crowd creates what we
call “the brain of the crowd”, which controls the individuals’ actions when they
are dealing inside the crowd.

• The effect of the “brain of the crowd” on its members creates what we call
“The Herd Theory”.

17
Crowd psychology

What is the brain of the crowd?

The lump sum of all participants.

According to British social scientist, Gregory Bateson (1904 – 1980), “mind” is actually a logical
process involving all the different aspects of self-organization and learning.

An individual’s mind may be regarded as a subsystem of the greater whole, where, in turn, the
whole has its own “collective mind” to organize its parts.

Each crowd may be said to have a “collective consciousness”.

18
Brain of the crowd

Brain of the crowd

• An irrational brain (its highly emotional).

• Affects the ability of individual brains to think for themselves.

• Its effect magnifies during important critical events such as market peaks and
bottoms.

• Members of a crowd are influenced by the “brain of the crowd”, which leads to
irrational behavior as their ability to think (individually) is suppressed.
19
Crowd is always wrong during major market reversals

The Dutch Tulip-mania

The close relationship between the tulip-mania that

appeared in the 1600s in Holland and the stock market
peaks (NASDAQ peak during 2000) suggests that crowd
psychology does not change with time, and it does not
change with wealth and/or technology.

20
Crowd is always wrong during major market reversals

The Dutch Tulip-mania

• A tulip, known as "the Viceroy", displayed in a 1637 Dutch catalog. Its bulb cost
between 3000 and 4200 florins depending on size. A skilled craftsman at the time
earned about 300 florins a year.[

21
Crowd is always wrong during major market reversals

The South Sea bubble

22
Crowd is always wrong during major market reversals
Daily Q.CASE30 [Bar, VOL] Daily Q.IXIC [Bar, VOL]
[Professional] 10/27/2005 - 3/14/2006 (GMT) [Professional] 12/15/1998 - 10/11/2000 (GMT)
Price Price
EGP USD
8200
4800
8000
4600
7800
4400
7600
4200
7400
4000
7200
3800
7000
3600
6800
3400
6600
3200
6400
3000
6200
2800
6000
2600
5800 2400
5600 2200
5400 2000
5200
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct
06 13 20 27 04 11 18 25 02 12 19 26 05 12 19 26 05 12 1999 2000
Nov 05 Dec 05 Jan 06 Feb 06 Mar 06

Daily Q.DSI 10/31/2004 - 4/24/2006 (GMT) Daily Q.SASI [Bar, VOL]

Price [Professional] 3/6/2005 - 5/30/2006 (GMT)
AED Price
1,200 SAR
1,150 20000
1,100
19000
1,050

1,000 18000

950
17000
900

850
16000

800
15000
750
14000
700

650 13000
600
12000
550

500 11000

450
10000
400
.12 9000
01 16 01 16 02 16 01 16 01 16 01 17 01 16 01 16 01 17 01 16 01 16 02 16 01 16 01 16 02 02 16 01 16 02 16 Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May
Q4 2004 Q1 2005 Q2 2005 Q3 2005 Q4 2005 Q1 2006 Q2 06 2005 2006
Crowd is always wrong during major market reversals
Extreme Optimism
New Era talks “Cisco will be the 1st trillion dollar company”
Best selling books

Spread of stories in media

Much higher valuations from

professionals

Properties are being sold for

the sake of investing
sounds very familiar!

Stock market reports published in unspecialized

magazines (& new TV channels for women and family)

Every one is Bullish

Everything Looks GREAT

24
Crowd is always wrong during major market reversals

Extreme Optimism

Much higher valuations from

professionals
Properties are being sold for
the sake of investing
sounds very familiar!

Stock market reports published in unspecialized

magazines (& new TV channels for women and family)

Every one is Bullish

Everything Looks GREAT

25
Crowd is always wrong during major market reversals
Daily Q.HRMS 9/22/1996 - 10/7/2004 (GMT)

Extreme pessimism
Price
EGP
20,000
19,000
Bad economical situation 18,000

17,000
Weak fundamentals
16,000

15,000
No interest in the stock market
14,000
anymore
13,000

Searching for new careers 12,000

11,000

10,000
9,000

8,000

7,000

6,000

5,000

.12

Volume
Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 EGP
1996 1997 1998 1999 2000 2001 2002 2003 2004

26
Crowd is always wrong during major market reversals

Real size

Apparent size of the good news

27
Market phases “Cycle of emotions”

Disbelief

Belief

Disbelief

28
Market phases “Cycle of emotions”
Euphoria “Everything looks Complacency “Its just a
great, this is here to stay!! temporary correction in
I’m going to margin up” prices…just profit taking nothing
to worry about”
Disbelief Disbelief
Anxiety & Denial “Hmmm…maybe I
Thrill “I ‘m on a roll…just cant go shouldn't've been so aggressive as to margin up”
wrong even if I try. I just know it all!!” This is crazy…the market is just wrong….this
company is great

Belief “I was right!!” Belief

Panic
Optimism “The “OMG….something is
market is good, I see a not right…..I cant
good company, I'm going believe the losses...I’m
all in” going to sell”

Disbelief
Disbelief “This one is
“This one is probably
Hope “This one Capitulation probably no
no different from the & Anger “This different from
previous rallies which is starting to look
different…maybe whole thing is the previous
failed” rallies which
things can be wrong….I’ll never
failed”
better” invest again….this Depression “I cant
isn’t my fault!!!” believe this happened to
me…its just my bad
luck….I’m worse off than I
started…there is just no
hope for me” 29
Technical Analysis

• Technical Analysis is the study of market action (in terms of price & volume),
primarily through the use of charts, for the purpose of forecasting future price
trends.

• Price movements are the result of the demand and supply created by the investors
(the crowd).

• Thus Technical Analysis is indirectly studying the behavior and psychology of the
crowd.

Premise & concepts in TA

• Investors are largely Irrational

• Market action discounts everything
• Prices move in trends (and trends persist)
• Investors’ (crowd) behavior is repetitive to a great extent

30
Technical Analysis

Fundamental Analysis studies: Technical Analysis studies:

- Studies the relevant factors affecting - Study of market action through the use
the share price of a specific company in of charts.
order to conclude the intrinsic value of
that share.

- Studies the cause of market movement. - Studies the effect of the market
movement.

31
The reasons of market movement are not known (to almost everyone) during market reversals
Enron
Crowd is always
wrong during
major market
reversals
March 12 $61.27: Lehman “Strong Buy”

March 14 $62.75: Commerzbank “Accumulate”

March 21 $55.89: Merrill “Buy”

March 29 $55.31: Goldman “Recommended” R

April 16 $59.44: Goldman “Recommended” R

April 17 $60 : Merrill “Buy” R

April 18 $61.62 : Goldman and Commerzbank, reiterated

June 8 $51.13: Bearn Stearns “Attractive”

June 15 $47.26: JP Morgan “BUY”
June 20 $45.8: Goldman “Recommended” R
July 10 $49.22: JP Morgan “BUY” R
August 15 $40.25: Bank of America “Strong Buy”

Sept 26 $ 25.16: AG Edwards “Upgraded to Strong Buy” Fraud news!

Oct 3 $ 33.49: Goldman Sachs “Recommended” R
Oct 4 $ 33.1: AG Edwards “Downgraded to Buy from Strong Buy”
Oct 5 $ 31.73: First Albany “Strong Buy” R
Oct 9 $ 33.39: Merrill Lynch “Raised to Long-term Buy”
Oct 16 $ 32.84: Merrill Lynch “Accumulate”” Oct 24 $16.41: Lehman “Strong Buy”, First Albany “Cut to Buy”, J.P, Morgan “Long-Term Buy”
Oct 17 $ 32.2: First Albany “Strong Buy” R
Nov 1 $11.99: Merrill “Cut to Near-term neutral”
Oct 19 $ 26.05: AG Edwards “Cut to Hold”
Nov 7 $9.05: AG Edwards “Sell”
Oct 22 $ 20.65: CIBC “Buy” R
Prudential “Downgraded from Buy to Hold”
Weekly Q/ETFC.O, Q.EGX30 7/17/2005 - 11/9/2008 (NYC)

BarOHLC, Q/ETFC.O, Last Trade E-Trade Price

10/18/2009, 1.71, 1.79, 1.63, 1.75 USD

25

24

23

22

21

20
19

18
Goldman Sachs, Buy UBS, Buy To Neutral 17

Prudential, Overweigh 16

Morgan Stanley, Overweigh 15

Credit Swiss, Neutral 14

UBS, Buy Deutsche Securities, Buy To Hold 13

Deutsche Securities, Buy 12

11

10
9

7
Cirigroup, Hold to Sell
6

2
.12
A S O N D J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J A S O N
Q3 2005 Q4 2005 Q1 2006 Q2 2006 Q3 2006 Q4 2006 Q1 2007 Q2 2007 Q3 2007 Q4 2007 Q1 2008 Q2 2008 Q3 2008 Q4 08
 MobiNil share price

Don’t sell!
large institutions
are buying!!!
Thank you!

35