"...fear and greed, will forever occur in the investment community... Our goal is more modest: we simply attempt to be fearful when others are greedy and to be greedy only when others are fearful."
- Warren Buffett [1]
As an investor, it is imperative to keep in mind that the value of a company is related to the number of earnings it should generate over the course of its operations. The contemporary debate on what causes stock markets to behave the way they do will always include a theme of irrationality versus rationality. Many attempts have been made to model the inner workings of the stock market and how to consistently outperform it.
While many investors, particularly hedge funds and similar investment houses, have surpassed the market year in and year out, there is always the risk of the unexpected. COVID-19, for example, had market effects that were almost unprecedented in over a century. Emotions like fear and greed frequently motivate investors, notably in aggregate. Greed generally keeps people buying and bidding up prices at the prospect of ever-increasing returns or profits when markets are growing. Consequently, asset bubbles may form and finally burst. For many, people these market recessions happen at the worst possible times leading many to liquidate at a loss or even worse. '
"Human behavior flows from three main sources: desire, emotion, and knowledge."
- Plato [2] Unfortunately, most investors are susceptible to emotional biases resulting from behavioral finance. Many investors, even professionals, make inherent mistakes due to following the herd responding to what is commonly referred to as FOMO or fear of missing out. Other examples include decision-making based on emotions such as excitement, or conversely fear or anxiety. Paradoxically the smartest among us can suffer from self-attribution, where overconfidence from one particular background or intrinsic skill base can leave even the best of us dumbfounded. Furthermore, a study in 2017 by Teresa Corzo Santamaría and M.G. Igual built a conceptual map that details exactly how overconfidence, loss aversion, herding, and other behavioral predilections account for the lack of connection between risk and return in financial markets. [3] Even seemingly less emotional-based decision making such as fixating on the price of a stock and making subsequent judgments about it is an irrational bias toward an arbitrary benchmark value. In fact, prospect theory states that we make judgments relying on an inherent set of heuristics and that we judge outcomes against the reference points given by our internal set of criteria rather than their probability.
As much as most of us would like to believe we are cool as a cucumber and calculated when making investment decisions, there is always some proponent of an emotional bias that afflicts our decision-making processes. Granted, this bias can be drastically mitigated through proper and thorough due diligence in fundamental and technical analysis but that bias will always remain a factor at play. Arguably, it is quite evident that rationality is not fully reflected in stock prices as the Efficient Market Hypothesis (EMH) theorizes. For those who are less familiar with this hypothesis, it determines that share prices are consistent with all information available to investors. In other words, stocks should trade at exactly their fair value on exchanges and thus never be significantly undervalued or overvalued and consequently unfeasible to outperform the market. [4]
"...the test of investor’s rationality is conducted within the frame of key assumptions like homogeneous expectation, information efficiency etc., the orthodoxical meaning of rationality does not always hold true..."
- Journal of Economic & Financial Studies, Farida Yasmeen, Md. Abu Syeed & Md Al Mamun
History has shown time and again that investors are not that rational as well as a number of studies concur with this conclusion. For instance, a study published in 2015 in the Journal of Economic & Financial Studies titled "Are investors rational, irrational or normal?" elaborates in great detail that investors are painfully human. [5] While some decisions are sensible and calculated, many are made on the spur of the moment. Humans prefer to evaluate new things predicated on our own existing experience, whether it's discovering familiar patterns in places where they aren't really there, such as pareidolia which is the phenomenon of seeing faces in common objects. We have all experienced this. When a completely new scenario is being assessed through the lens of some previous experiences, there is an inherent bias that we cannot escape.
So is all hope lost?
No, particularly in this contemporary age where artificial intelligence (AI) has become the groundbreaking technology of the future.
The Artificial Intelligence (AI) Advantage
Artificial Intelligence (AI) is taking the world by storm by becoming more integrated into how companies do business, and how our technologies are evolving and Wall Street hasn't missed out either. The global AI adoption rate has progressively increased and presently stands at 35% which is a four-point gain over the previous year according to research commissioned by IBM in partnership with Morning Consult in the IBM Global AI Adoption Index 2022. [6] It should as no surprise that AI is being included in stock trading instruments on Wall Street and is now starting to become available to individual investors.
"Older people sit down and ask, 'What is it?' but the boy asks, 'What can I do with it?'."
- Steve Jobs [7]
Welcome to the future of market analytics. Only in the last decade or two have computers become capable of processing massive volumes of data, looking for patterns and establishing meaningful relationships between factors, entire agglomerations of variables, and specific results. These extremely complex statistical programming and modeling, mathematical functions in conjunction with machine learning (ML) are capable of assessing their existing algorithms and coefficients against newly inputted data and thus subsequently adapting to enhance the precision of the models by upgrading through a process of validation and reflection. This in conjunction with the historical accuracy of each previous financial asset prediction correlates to how the AI system assesses what we refer to as the Signal Confidence (SC) and is reflected as a percentage out of 100%. Granted, the AI system will never assign an SC of 100% because this level of certainty is physically not possible. There will always remain unforeseeable variables.
By analyzing the empirical evidence of financial market anomalies related to the overreaction and under-reaction of traders allows the AI system to publish circadian forecasts at six different frames from the short term to annually. It should be noted that the SC percentage will be much stronger for the longer time intervals than the shorter time horizons as the AI system tends to be much more accurate at precisely recognizing longer-term trends.
"The reason AI is advancing rapidly is that we're at 2.5 quintillion bytes of data being produced each day," Krishna said. "That's 2.5, followed by 18 zeros. There is no way any amount of humans are ever going to process that. Old analytics and database techniques are insufficient. AI is the only tool able to harness and harvest that data for insights."
- IBM CEO Arvind Krishna [8]
The huge advantage of utilizing artificial intelligence for stock market research is that AI is able to constantly monitor more assets at all times of the day without bias. AI doesn't have bills to pay, a wife/husband or a family that they are indebted to, or an ego to contend with. As much as you want to believe that you do not have an ego, the truth of the matter is that we all do. That is an inseparable part of being human. Artificial Intelligence, on the other hand, is using big data analytics for deciphering a copious volume of high celerity of a vast array of data. Big data analytics can ultimately enable better and faster decision-making, future outcome modeling and forecasting, and enhanced market intelligence.
Enhanced Market Intelligence
Enhanced market intelligence is the key here. Finding market opportunities is made easier by using our AI system. It doesn't tell you what to do. It tells you where to look. Concertedly, our professional team of analysts validate the AI outputs and extend this market research with a personal touch giving our subscribers tremendous value. If you would like the AI advantage working for you, then you should subscribe today!
Life is better when you can be bullish.
Sources: 1. Berkshire Hathaway, Inc. "Chairman's Letter" (1986)
2. Goodreads LLC "Plato > Quotes"
3. Resarchgate.net "Overconfidence, loss aversion and irrational investor behavior: A conceptual map" (2017)
Comentários