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BF W11 - Coggle Diagram
BF W11
behavioral trading strategy
3 assumptions
investors make behavioural mistakes
your trading should be
opposite
to the mistake
greedy when others are afraid, and afraid when others are greedy
in the long run, price will converge to the fundamental value
used by large institutional investors with great capital (hedge/mutual funds) NOT retail investors
BECAUSE this strategy needs quantitive trading (quat trading)
use research to find
anomaly
anomaly:
abnormal returns that can't be explained by traditional risk factors -> contradict traditional finance
ex: salient effect: investors are attracted to stocks with salient upsides -> overvalued and earn low subsequent returns. Opposite to salient downside stock
5 steps
Step 1
identify the anomaly that you wanna use in your behaviour trading strategy
ex: salient effect
connect anomaly to behavioral biases or theories
ex: system 1 -> consume less energy -> limited attention -> availability bias + representative bias -> salient effect
step 2
sort all investments in the same market by the anomaly factor
ex: process
sort close price from high->low
choose 200 top and 200 bottom firms after sorting, ignore firms in the middle -> to represent the salient effect
quantify anomaly factor using closing price of the stock
use datanalysis premium rmit
to calculate return from historical data of stock price in medium term (1m<x<12m)
step 3
set investment into 10 deciles based on the anomaly factor
ex: see slides w11
step 4
create the strategy
key: identify which investments in which decile is most over/undervalued -> short/long the investment in these deciles
ex: long the firms in lowest decile (least salient) and short firms in highest decile (most salient)
step 5
test the (systematic) risk of the portfolio
ex: test whether the difference between firms in highest decile and lowest decile is derived from risk
ex:test at least whether market risk drives your result
calc raw return in future and market adjusted return (=raw retrun-market return at the same period) to control market risk
NOTE:
no need to calculate in asm, only describe