CHAPTER 19
Behavioral Finance and Technical Analysis
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Behavioral Finance Traditional theory ignores some aspects
of personal behavior Behavioral finance tries to incorporate
personal behavior to extend corporate finance
Behavioral finance is a developing area
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Individual Behavior Cooperation and Altruism Bidding and the Winner’s Curse Endowment Effect, Status Quo Bias and
Loss Aversion Mental Accounts
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Asset Returns and Behavioral Explanations
Calendar effects Cash dividends Overreaction and mean reversion Controversial explanations from
behavioral finance– Closed-end fund pricing– Excess volatility in stock prices
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High
Low
Close
Price
Days
Sample Price Chart
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oo
oo
Congestion areas
Sell
Point and Figure Chart
Price
x
x
x
x
x
x
xx
x
x
x
x
x
x
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Sentiment IndicatorsTrin Statistics
# Advancing / # DecliningVolume Advancing / Volume Declining
# Declining / Volume Declining# Advancing / Volume Advancing
If Trin > 1.0 bearish signal
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Sentiment Indicators Put / Call Ratio
– Historical value 65%– When higher than 65% a signal occurs
Bearish view Bullish view
Mutual Fund Cash Position– Cash levels are low - bearish sign– Cash levels are high - bullish sign
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Sentiment IndicatorsOdd - Lot Trading Ratio of odd-lot purchases to odd-lot
sales When ratio exceeds 1.0, bearish sign Contrarian logic - small investors are the
last to buy in bull markets
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Flow of Funds Indicators Short Interest - total number of shares that are
sold short– When short sales are high a signal occurs– Bullish interpretation– Bearish interpretation
Credit Balances in Brokerage Accounts– Investor leave balances when they plan to invest in
the future– When levels are high a bullish sign
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Market Structure IndicatorsMoving Averages Average price over some historical
period (5 weeks or 200 days) When current price crosses the average
a trading signal occurs Bullish signal when the current price
rises above the moving average Bearish sign when the current price falls
below the moving average
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Market Structure IndicatorsBreadth The extent to which movements in a
broad index are reflected widely in movements of individual stocks
Spread between advancing stocks and declining stocks
Also used in industry indexes
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Value Line System Widely followed with some evidence of
superior performance Value Line System is predominately a
technical system– Earnings momentum– Relative stock prices– Ratios of moving averages
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Value Line System Paper vs actual performance indicates
that the system is difficult to implement– Value Line Fund has not shown superior
performance– High turnover costs are associated with the
strategy Evidence shows prices react quickly to
reported ranking changes
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