How Charts Influence Decisions to Buy and Sell Stocks

Abstract (Via Thomas Mussweiler and Karl Schneller Journal Of Behavioral Finance)

Five experiments examine how charts depicting past stock prices influence investing decisions.We expected investors to use extreme past prices depicted in charts as comparison standards to which expectations about future prices are assimilated. Investors should thus expect stocks depicted in a chart with a salient high to perform better than stocks depicted in a chart with a salient low. And as a consequence, investors should be more likely to buy and less likely to sell stocks depicted in a chart with a salient high than a low. Results of five experiments support this reasoning. Whether investors are private or professional and whether background information about the stock was limited or abundant, expectations about future prices assimilated to extreme past prices. Consequently, investors buy more and sell less when the critical chart is characterized by a salient high than a low. The implications of these findings for the core role comparison processes play in investing decisions are discussed.

Additional Excerpts (Via Thomas Mussweiler and Karl Schneller Journal Of Behavioral Finance)

Because investing decisions are above all decisions, they are unlikely to be an exception to this well established principle of the relativity of human judgment. Past stock prices provide particularly salient comparison standards that could be used as a basis for investing decisions. But why should investors use such prices if they are merely the product of a “random walk down Wall Street”

Part of the answer may involve the complexity of investing decisions. When trying to decide what to do with their money, investors face a myriad of decisions. Should they invest in mutual funds, stocks, or bonds? How should they weigh these different investment types? Which particular fund, stock, or bond should they put in their portfolio? These decisions are painstakingly complex, not only because of the number of potential options but also because of the endless stream of information that comes with each one. Furthermore, investors also must decide when to invest. Markets fluctuate immensely, and investment success depends very much on timing—as any investor who bought an Internet stock in the spring of 2000 can confirm. In short, investing decisions are overwhelmingly complex.

Because of this complexity, investors cannot find the “best” possible investment. As in many domains of human judgment and decision-making, investors must “satisfice” and be content with decisions that seem reasonably good. Judgmental heuristics—mental shortcuts that turn complex decisions into simple judgment tasks—are a major tool for satisficing . In fact, the use of judgmental heuristics appears to prevail in virtually every domain of human judgment and decision- making  and economic.

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15. December 2009 by Miguel Barbosa
Categories: Behavioral Economics, Curated Readings | Leave a comment

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