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The starting research plan

I had my initial formal meeting with my PhD supervisor over the course of Friday and Monday to set the path for my research and development, at least initially. Basically, that means working out where I need to enhance my research skills (read econometrics in this particular case) and defining at least the basic framework for my research. And naturally the result of that is coursework to do (I need to audit two course this year) and a list of recommended readings. Good thing I like to read because I fully expect to have constantly be working from a list of recommended books, papers, and journal articles. 🙂

As for where I’m to direct my initial research, since my focus will mainly be on Behavioral Finance, it will come as no surprise that I will be starting off by looking at two of the primary Behavioral subject areas. One of them is Prospect Theory and the disposition effect. It is a bit more complex than this, but from a trading perspective it basically boils down to taking profits too early and holding on to losers. This is a psychological bias we have related to the imbalance we perceive between losing and winning. We view the pain of losing as worse than the joy of winning.

The other key research concept I’ll be looking at is the view that overconfidence drives over-trading, and how the latter can lead to under-performance. This idea was most notably put forward in a paper titled “Trading is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors”. The conclusion of the authors is that overconfidence in one’s ability to trade the markets leads traders/investors to be more active in the markets than they should be, leading them to perform worse than had they traded less frequently, or not at all.

The main research to-date in these subject areas has been focused on the stock market. I will be using forex traders, which by all accounts are a much more active bunch, to see if the theorized patterns hold. Some of the initial research I’ve done supports the disposition effect, but asks some questions about the linkage between trading activity and performance, but we’ll see how things fall out when I really get into proper analysis.

This may not exactly be mind-blowing stuff, but it’s a foundation and there’s no telling what I see in the data through the research process.

By John

Author of The Essentials of Trading

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