When it comes to investing or trading, the most important insight for any individual is how psychology and emotion are affecting their buy and sell decisions. This helps explain why two people with access to the same information and applying the same investing techniques can have widely variable returns. For those not familiar with this field, Paul Azzopardi provides readers with an excellent introduction to it in his new book ?Behavioural Technical Analysis: An Introduction to Behavioural Finance and Its Role in Technical Analysis." (Harriman House, 2010)
Behavioral finance goes way beyond the usual greed and fear aspects of investing that everyone knows about and deals with how people approach complex systems (and few systems are more complex than the stock market); how perception rarely provides an accurate picture of what is taking place; the difference in reactions to investment losses versus gains; different type of thinking patterns; and how people and markets are influenced by crowd behavior. Having an understanding of your own individual style and group psychology gives you a powerful tool to avoid losses and increase your gains.
While the various behavioral issues of investing impact everyone, they do so to different degrees. Individuals need to improve on their weak points and develop trading approaches that are consistent with their own personality. Other directed social types are better off playing a trend, while independent free thinkers are better off taking a contrarian approach. Azzopardi has developed a simple model of traders and investors moving from long to short or not in the market and from trend following to contrarian to undecided on market direction to explain changes in prices. While this does offer an interesting way of looking at the relationship between changing opinion and stock prices, these categories may not be a fluid as he proposes.
Behavioral finance also explains why bubbles and crashes take place and they do so over and over again. Human psychology hasn?t changed in the last several hundred years, nor is it likely to change in the next several hundred. Trends both up and down develop because humans are social animals and they copy what other people doing. A logical understanding of this doesn?t prevent reoccurrence because emotion is the underlying cause. Those who study the history of markets, and this includes some of the most successful investors of all time, are actually indirectly studying behavioral finance.
Technical analysis is essentially various ways of providing a picture of group psychology of investors. It also tends to highlight the actions of the big players that determine the direction of the market. Azzopardi only lightly touches on a few areas of technical analysis in his book with some examples and doesn?t deal specifically with the influence of the larger traders. They are presumably affected by behavioral factors as well. For readers who want detailed explanations of technical analysis, the books by John Murphy and Thomas Bulkowski would be good choices.
Those who are looking for a clear, easy to understand introductory book on behavioral finance should take a look Azzopardi?s book, ?Behavioural Technical Analysis.? It provides a number of key insights that could potentially improve your trading or investing significantly. If you are already very familiar with the field, a more advanced book would be appropriate. On the other hand, if you don?t think behavioral factors apply to your investing, you might want to go to a dictionary and look up the definition of "denial."
