Finance and Stuff

Thoughts on finance and other stuff by Johan Lindén

Tag: Behavior Economics

Do You Understand Financial Markets?

Many think that they can easily understand human behavior and financial markets by reading financial press and use common sense. But when an outcome is based on complex factors such as human behavior, than outcomes can be counter-intuitive.

For instance, how would you like to bet on the Euro compared to the US Dollar? Most people would find that to be a really bad idea. However, we have had two years of horrendous news from Europe, and the Euro still gained (sic!) from $1,23 to $1,25 during this period. Who would have thought?

Another example of how complex human behavior is, or perhaps very simple and narrow-minded in some way, can be found in this graph from the betting firm Intrade. Below you can see the very close correlation between the S&P500 and how likely it is that Obama gets reelected. So it seems that reforms, tax-breaks, and competing candidates seems to matter very little compared to how the stock market performs.

obama sp500 stock market reelected

Lesson to be learned, don’t think common sense as applicable to the financial markets, and with common sense I mean readily available information. The greatest brains in the world are setting the prices and they are not easily fooled. You rather have to think three steps ahead rather than one or two steps ahead.

Most People Should Rely on Passive Investment

The intelligence of the average stockholder is probably above the population average. Still they cannot bet the index. That is to say they cannot even beat random guessing, a coin flip, or similar, as the chart below shows.

Active vs passive investment decision-making

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