Sunday, August 31

Does every cloud have a sell order lining?

While my days of sitting in front of a trading screen are now long ago and lost in the dim and distant past, every time I pass a trading screen, the familiar tightening of the chest, thumping of the blood and dampening of the palms still happen. How prices are made in the financial markets is a fascinating phenomenon. The theory is pretty simple. The current price of an asset in the markets is supposed to be best estimate of all the participants of the future performance of the asset. So if the price drops, then the market (or people like you and me) expect that the future performance will be bad. Of course there is much more to it than this.

We are not all Vulcans; we do not have a straight forward unemotional way of judging the future. Strange things do impact us. If I woke up, toddled off to take a shower and found that the hot water has finished, I would be miffed. My day would not be good after this not so good start and frankly I would not be in a good mood. My performance, my duties and responsibilities, my behaviour towards my family, colleagues and friends, howsoever tiny and picayune, will deteriorate. I will go about my day being grumpy and expect the future to be dark.

If I was woken up by my 4 year old little girl who clambered into bed with me early in the morning and then we spent 15 minutes whispering about frogs, princesses, flowers, babies, naughty elder brother, toys, dresses, boyfriends and so on and so forth, then I get out of bed after getting a big hug and a whispered, “you are the bestest daddy”, that’s it, my day is made. I will go through the day with a spring in the step, a smile on my face, a twinkle in my eye, a song on my lips and heart on the sleeve. My behaviour would be good, and I will do my duties with a cheery smile and it would be a great day. I will think the future will be great and wonderful.

So my mood influences how I feel about how the future will be. And this is why good moods, good news and good feelings/emotions push economies and markets up. People feel good about the future so that they go out and purchase stuff, go take up credit, buy houses, spend money and invest in stocks. When the mood goes bad, they stick the money under their mattress, sell their investments, plonk cash into gold and so on and so forth. Governments therefore constantly try to keep giving good news, putting a positive spin on things. That’s why they love big spectaculars, the 100th anniversary of the country’s founding, the Olympics, the Birthday of the President/Queen, the launch of the first hospital, etc.. Good things, things that make you want to celebrate and feel good about the future. (Also if you feel good, you will re-elect the government…)

Since moods influence our perception of the future so much, it is not surprising to hear that stock prices are sensitive to time. For example, did you know that stock prices move differently on Mondays and in January? Or that they move differently between summer and winter? Yep, not only does time influence trading, the weather influences trading as well. And I was reminded of this when I read a recent paper by Chang, Chen, Chou and Lin in the Journal of Banking and Finance (2008, 32, 1754-1766). These doughty chaps went deeper into the weather and trading relationship to explore how prices moved intra day. In other words, is there a relationship between the prices on the New York Stock Exchange and the weather patterns during the day? As it turns out, yes Sir, there is indeed a relationship. Stock returns are lower on cloudier days. You have more seller initiated trades during market open if the weather is cloudy (akin to your hot water running out?). When the skies are cloudy, the price jumps about much more and does not settle down as much all through the day. There is a ton of research on this topic already, human bio-rhythms do drive trading and economic behaviour.

Strange, no? You normally would not expect the valuation of your pension fund or your mutual fund to be influenced by something as silly as the weather, would you? Especially when the offices these days are all air conditioned, with scientifically calibrated lighting and all the modern conveniences, and so on and so forth. And after all that, you find that those highly paid traders are being impacted by cloud cover? And you call yourself as BSD’s? Pah, buy some umbrellas, you wimps!

(PS: this has nothing to do with investment advice at all, please do not invest based upon this essay)

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