The Psychology of the stock market

• Before psychoanalyzing the stock market, we need to make sure we have an idea of what the stock market is. In short:
• Stocks are traded on the stock market
• A share of stock represents ownership of a fraction of a corporation

Brief stock market introduction

• Everyone's goal in the stock market is to make money

• However, the stock market is a zero sum game
• Traders are usually described as either technical or fundamental

Refers to the fundamental, objective, or "real" value of an asset

The money a company has left over after paying its operating expenses and capital expenditures

What drives stock price?

• The relationship between the quantity of a commodity that producers wish to sell at, and the willingness of that consumers to buy (at a certain price)

• To get a better understanding of supply and demand we are going to run a class simulation-get your phones out!

• https://www.breakeven.app/

• If Instagram or Snapchat started charging for usage would you pay? How much and why?

• What experiences have you all had with supply and demand? Have you ever given in to higher prices due to scarcity (Ex: concert tickets)?

• Do buyers (demand) or sellers (supply) control markets or something else?

• What are your thoughts on a monopoly (A market structure characterized by a single seller, selling a unique product in the market)?

Includes the attitude of investors toward a stock, or the market as a whole.

When new information relating to a company or the general market is released. It can be negative, or positive

Extreme example of supply and demand

Case 1: Lehman Brothers

• Declared bankruptcy on September 15, 2008, after 158 years of existence

• With $692 billion in assets and $613 billion in debts, it was the largest bankruptcy ever

• Their stock dropped 93% in one day

• It also left 25 000 employees jobless

Extreme example of supply and demand

Case 2: Game Stop

• Was a brick-and-mortar game retailer with an outdated business model
• Had its stock price tank from $10 in 2014 to $0.8 in 2020
• Large Wall Street banks expected GME to go bankrupt, and so they shorted the stock (meaning they entered a somewhat risky position based on the price declining further)
• Some people on the internet forum r/wallstreetbets realized that that position could be exploited if enough people bought the stock
• https://www.investopedia.com/terms/s/shortsqueeze.asp

In summary...

• The driving factor behind the price of a stock is the perception, of said stock
• This perception can lead to buying or selling the stock
• Two emotions which may skew perception are fear and greed

To summarize

Foundations of Technical Analysis

• The idea behind technical analysis lies in analyzing statistical trends gathered from trading activity.

• A key belief of a technical trader is that past trading activity can be used to dictate with some form of accuracy a security's future price movements.

• Technical traders use a variety of

Technical Analysis

Foundations of Fundamental Analysis

• The objective of a fundamental trader is to identify the intrinsic/fair value of a security in relation to the overall market

• They arrive to this conclusion through two distinct pathways, as well as two general views:

Fundamental Analysis

Bonds

ETFs are a pooled investment that focus on tracking a sector (microchips, automotive), index (S&P 500, Russel 2000), or commodity

Exchange Traded Funds (ETFs)

• Positions are held anway where from a couple days to a couple months (short to medium term)

• Is generally heavily based on technical analysis. Specifically, momentum, volume, etc.

• The aim of a swing trade is to profit off of a section of a price movement

Swing Trading

• Involves entering and exiting positions within a trading day

• Has a relativly large learning curve

• Heavily rely on, and are known for their use of technical analysis

Day Trading

• An option is a contract that gives the owner the right, but not the obligation, to buy or sell a stock at the described price and date.
• Here are the two types of option contracts and how they work:

Option Trading

• Commodities include things like a raw materials or agricultural products
• They can be traded through contracts on a separate exchange to the NASDAQ, TSX, or NYSE

Commodities

• In short, cryptocurrency are unregulated, decentralized, virtual currencies that are based on blockchain technology.

• While not being a stock, many lessons and strategies cross over into cryptocurrency.

• That being said crypto is notorious for being much more volatile, than other traditional assets

Cryptocurrency

Trading with no experience

Technical vs Fundamental investing summarized

Mutually exclusive how?

Charm Pricing

Price Anchoring

At the same time, it has been found that consumers tend to be heavily swayed based on an initial piece of information, like price (the anchor) when decision-making.

1:13:43-1:14:54

• When retailers end prices with odd numbers, usually 9, customers are much more likely to buy them
• The University of Chicago & MIT set prices of clothing at $34, $39, and $44, and found that $39 sold best.

• The opposite of this effect is prestige pricing. That being an even odd digit at the end of a product

• According to research from the Journal of Real Estate Finance and Economics, lowering a list price down from $300,000 to $299,000 yields a premium of 2.5% to 3% when the home sells.
• However, cutting the list price from $250,000 to $249,000 doesn’t have an effect because only the leftmost digit matters in this principle

Pricing

Emotions

• In the book, Descartes' Error, Antonio Damasio, professor of neuroscience at the University of Southern California, explores how emotion is a necessary to, and plays a large role in most decisions.
• He conducted a study featuring people whose connections between the “thinking” and “emotional” areas of the brain were damaged.
• He found that they were capable of rationally processing information about alternative choices, but were unable to make decisions, because they lacked any sense of how they felt about the options.
• Other research found that consumers are more likely to buy or choose a product when they're experiencing positive emotions

Colour

• Of all the 5 main senses humans have, the one we use the most by far is vision
• Almost 40% of website visitors stop engaging if images don’t load
• 93% of consumers self-identify that appearance is the first thing they consider when making a purchase

• Social proof is a well documented idea in psychology that claims people are influenced by others actions/choices. Especially so if:

Asch conformity experiments

Social Proof Theory

• The person in question is close (friends/family)
• Powerful/influential (celebrities)
• Or when in a group of many people

This can easily be used against us. A few examples include:

• Using influencers and famous people to make a product/service more desirable. On a subconscious level, we may associate their good qualities with the product
• Implying popularity. "Sold out!" This creates an aura of desirability
• Reviews and ratings. 70% of people check them before making a purchase, to see what others think about a product or service.

• Volatility is a natural part of the stock market, and you shouldn't be frightened by it.
• The last person who claimed that they were immune to volatility was Bernard Madoff, leader of the largest ponzi scheme in history; worth about $64.8 billion.
• As Morgan Housel put it, "Think of volatility as a fee not a fine." If you are fined for parking, you won't park there again. However, every time you park downtown, you pay a fee

The roller-coaster of volatility

• Daniel Kahneman, the author of Thinking Fast and Slow, argues that, "Listening to pessimists is an evolutionary trait. When directly compared or weighted against each other, losses loom larger than gains. Organisms that treat threats as more urgent than opportunities have a better chance to survive and reproduce.”

• Another reason for why pessimists seem smarter has to do with the fact that progress rarely happens overnight, but setbacks often do.

• Be careful when taking in advice, understand that you are evolutionarily programmed to be more receptive to negative news.

The pull of pessimism

• Many studies have discovered that wealth interferes with empathy and compassion. Research published in the journal 'Psychological Science' found that people of lower economic status were better at reading others’ facial expressions than wealthy individuals. Recognizing emotion being a key marker of empathy
• “A lot of what we see is a baseline orientation for the lower class to be more empathetic and the upper class to be less [so]. Lower-class environments are much different from upper-class environments. Lower-class individuals have to respond chronically to a number of vulnerabilities and social threats. You really need to depend on others so they will tell you if a social threat or opportunity is coming, and that makes you more perceptive of emotions,” the co-author of the study, Michael Kraus, told Time. “

• The University of Berkeley found that even fictional money has a large effect on the behavior of people. Researchers observed that when two students played Monopoly, one having been given a great deal more Monopoly money than the other, the wealthier player expressed initial discomfort, but went on to act aggressively and recklessly as the game progressed, taking up more space and moving his pieces more loudly, and taunting the player with less money.

Negative effects of wealth

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The secret to Warren Buffet's $100 Billion fortune