Trading Psychology  |  MAY 1999

Smart Money by Scott Brown

Smart Money by Scott Brown Should you develop a personal trading system, one that reflects your own personality? A belief persists among investors that a select group of traders have the inside edge. Some indicators, such as The Commitment Of Traders Report, try to track the activities of these traders. Some recent research may shed light on the composition of this group, as well as the techniques that the Market Wizards use to consistently beat the market. Once the market participant understands the areas that make a difference, he can use this knowledge to improve his trading performance. MARKET VOLATILITY Trading the markets is a social phenomenon. Investors are also greatly influenced by mass psychology. This could explain trendlines of markets in the limelight that have dramatic shifts in slope. An excellent example is the petroleum futures bubble at the end of 1990 that was sparked by the Gulf War (Figure 1). It could also explain stocks in low-volatility channels despite favorable earnings, growth and dividends at the end of bear markets when public interest is low. EFFICIENT MARKET HYPOTHESIS Random walk, or efficient market hypothesis (EMH), contends that past, present and future prices accurately reflect information coming into the market. Economist Robert Shiller of Yale University is one of the leading challengers of standard EMH. He emphasizes the role that popular opinion could play in volatility. Shiller’s research indicates there is more volatility in the market than the EMH model can account for; price may not always reflect value.

by Scott Brown, Ph.D.