Today, few people can completely stay out of the financial market, and investment has become an important means of personal wealth growth.
However, the investment market always feels unpredictable and unpredictable.
You can't make a lot of money in a bull market, but you lose money in a bear market;
Checking the rise and fall of individual stocks every day, but buying and selling did not make much money;
Full of confidence, I rushed into the bear market to buy bottoms, but found that there was only a lower level, not the lowest level;
Knowing that asset allocation is very important, the eggs are obviously put in different baskets, but the risk still cannot be avoided...
The mistakes people make in the financial market are the basic content of behavioral finance research.
There is a very brain-burning logic here: after all, the financial market is made up of people, people are irrational, and people make mistakes.
It's like a ping-pong game of equal strength. If you want to win, there are two rules for winning. You make fewer mistakes, and at the same time, seize every opportunity your opponent makes to attack.
Behavioral finance is to tell us how to make fewer mistakes in the financial market, and at the same time, how to make use of most people's mistakes and reverse operations to formulate trading strategies.
What is Behavioral Finance?
Behavioral finance explains, studies and predicts the development of financial markets from the perspective of micro-level individual behaviors and the psychological factors that produce such behaviors. This research perspective seeks the operating philosophy and decision-making behavior characteristics of different market players in different environments by analyzing the deviation and abnormality of financial market players in the market behavior, and strives to establish a system that can correctly reflect the actual decision-making behavior of market players and market operations. A descriptive model of the situation.
Can the irrational behavior of irrational people be predicted? Behavioral finance can.
Mistakes that most people are making can cause prices to go up or down in the short term, but in the long run, prices return to value. Once you have mastered such laws, not only can you predict the market, but you may even beat the market. This is what every trader needs to know.
Fund houses around the world are increasingly adopting behavioral financial trading strategies. The founders of the famous LSV fund are three professors of behavioral finance. With their research, more than 40 employees manage assets of 119 billion US dollars. Since its establishment in 1994, it has an unbeaten record in 25 years.
Wealth has two enemies: risk and fear
How does behavioral finance understand the world?
There is such a circulating joke. Someone exclaimed that there was a hundred yuan on the ground. Traditional financiers said that this is impossible, there should not be a hundred yuan on the ground, and if there were any, they would have been picked up long ago; but behavioral finance experts said, why is it impossible? He ran to take a look, and there were indeed, I happily picked up 100 yuan.
Traditional finance studies what the market "should be". From an equilibrium point of view, there should be no one hundred yuan on the ground. This is a long-term trend and law. Behavioral finance, on the other hand, studies what the real market "actually looks like".
Behavioral finance believes that the theory of "should be" cannot be used to guide actual decision-making, and this will cause problems. Just like when regulators face the market, they cannot think that the market is always right in the long run, and ignore it. If they had intervened in the market earlier, maybe the financial crisis would not have happened.
If you think about it carefully, in fact, any discipline and field can use these two ways to think about problems.
For example, physics looks at the laws of the universe from the perspective of "should be". From the perspective of physics, everything is a balanced presentation. From a biological point of view, each species "actually" captures its own chances of survival in the evolutionary process of survival of the fittest, so as to complete its iterative self-upgrade.
For another example, in the judicial field, jurists ensure the long-term fairness of the entire judicial system from the perspective of "should be", while lawyers collect evidence to fight for the rights and interests of their clients from the perspective of "actually".
So what is the use of having both perspectives at the same time? When we look at things in any field, the perspective of "should be" can grasp the long-term benchmark; the perspective of "actually is" can understand what is happening now.
The Fundamental Difference Between Traditional Finance and Behavioral Finance
If we compare traditional finance to a big tree, the tree has roots, trunks, branches, and leaves. The more rooted the theory is, the more fundamental it is. Any academic progress is due to new shoots and new leaves growing on a certain part of the tree. If the theory at the root does not hold, the whole tree will collapse.
So, where in the tree does behavioral finance diverge from traditional finance?
The answer is: root. Behavioral finance is fundamentally separate from traditional finance.
They have different theoretical foundations, have their own theoretical systems, and have grown into two complete trees.
However, the canopy part overlaps, that is to say, what issues are studied by traditional finance, these issues are also studied by behavioral finance. However, the starting points of the two are different, and the conclusions are quite different.
So, how are the roots of the two trees different? Let’s take an example to understand where traditional finance is rooted.
People often ask if they want to work in the financial industry in the future, what major should they study? In fact, the answer to this question is very simple, and there is a "standard" answer.
Finance, in terms of subject classification, is a second-level discipline, and its first-level discipline is economics, to be precise, it is called applied economics. What is the subject basis of applied economics? is mathematics. Therefore, the answer is very simple, the basic subject of mathematics for undergraduates, the first-level subject of applied economics for the master's degree, and the second-level subject of finance for the doctoral degree. This is the training path of financial standards.
Traditional finance believes that finance is just the manifestation of the basic economic theory in the financial market. And the most basic assumption of economics, or the root of the tree is - people are rational.
In short, everyone's decisions can be calculated mathematically, as precise as a robot. You can also understand a rational person as a robot. Robots don't make mistakes. Therefore, under equilibrium market conditions, the price of a financial asset observed at any moment is an accurate reflection of all information at that moment.
This is the "efficient market hypothesis", which is the root theory of traditional finance. The economist Eugene Fama who proposed this theory won the Nobel Prize in Economics in 2013.
Next, let's compare and see where the roots of behavioral finance lie.
In the 1970s, there were two scholars, one was a financier and the other was a psychologist. They often chatted together. The financier said that when we study... problems in financial markets, the conclusion is as follows... ..., the psychologist said, this seems wrong, right? Because from a psychological point of view, the result will not be like this.
Psychologists are right. Fundamentally speaking, finance belongs to social science, and social science studies the laws of social operation related to "people". Decisions about what to buy and what to sell in financial markets are made by people. Well, of course, finance should study problems from the perspective of people, not mathematics, and what people think and do is the research field of psychology.
Therefore, these two scholars began to study finance systematically from psychology and created the discipline of behavioral finance. These two scholars are Daniel Kahneman and Amos Tversky.
In 2002, Kahneman won the Nobel Prize in Economics, which marked the formal recognition of this discipline by the academic community. It is a pity that Tversky died young and missed this glory.
Features of Behavioral Finance
Literally, "behavioral finance" consists of the word "behavior" plus "finance". "Behavior" comes from behaviorism in psychology, which is the theoretical basis of behavioral finance.
Since Kahneman and Tversky founded the school of behavioral finance, more and more people have realized that this discipline can better explain various phenomena in the financial market. Since the 1980s, the theory of this school has grown rapidly, gradually forming a situation of confrontation with traditional finance.
At the end of the 20th century, some scholars even said: "I predict that behavioral finance will become a redundant term in the near future, because besides this, what other finance can there be?" A behavioral financier named Richard Thaler, he is the 2017 Nobel Laureate in Economics.
Of course, the later fact is that behavioral finance has not completely replaced traditional finance, and both theories are developing. However, compared to traditional finance, behavioral finance is more practical. Interestingly, Richard Thaler is often referred to as a "clinical economist." What does that mean? An economist who can solve practical problems.
Behavioral finance is best at investing in actual combat and formulating trading strategies. Most of the so-called "quantitative trading strategies" we often see now are based on behavioral finance theory.
Some of the people we see in the financial market were originally finance professors in universities and later turned to investment practice. They are generally behavioral financiers, while traditional financiers do more research than practice.
Moreover, the trading strategy based on behavioral finance does not even need to form a huge team, nor does it need to hire a lot of analysts to do research on each company. Many successful behavioral finance trading teams have even just a few people.
In the next series of articles, I plan to update some related content about behavioral finance and my own experience in content learning. If you have any ideas, please comment below. If there are any mistakes in the article, everyone is welcome to criticize and correct. (I will correct it in time if I find an error).
Thank you for your attention, I wish you a smooth transaction
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