Thursday, June 21, 2007

Use Behavioral Finance When Picking Stocks

Richard Thaler incorporated behavioral finance into money management by claiming that stocks not only react to information, but to noise creating from buying and selling trends. In short, investors cannot ignore the psychological state of fellow investors when pursing a potential trade.

I am a behavioral finance trader. In order to identify the psychology behind a stock I consult technical indicators. If a stocks technical indicators are strong, I consult their financials to insure its a good trade. If company revenues are rocketing, I look to see if investors have already priced in these expectations by looking at technical trends. While Wall Street is covered with analyst running valuation models, the market is still a supply and demand market driven by investor's willingness to pursue a stock at the current price. This market may sell-off on rumors of interest rate hikes, but will show equal losses when individuals take profit after a recent run-up.

What is an Investor to do?
Diversify your research like you diversify your investments. If you only look at three month chart, your going to get killed. If you look at last years books, your going to get killed. If you happen to notice that the company is expecting an financial sound acquisition sometime in the next several months, and the stock has shown a shift from selling pressure to buying pressure, it may be a perfect time to go long.

In the next few weeks, I plan on sharing several fundamental and technical methods of research. Feel free to share some of your favorites!


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