On the Trend Recognition and Forecasting Ability of Professional Traders

Abstract

E mpirical research documents that temporary trends in stock price movements exist, so that riding a trend can be a profitable investment strategy. In this paper, we provide a thorough test of the trend recognition and forecasting ability of financial professionals who work in the trading room of a large bank, as well as those of novices (students). In an experimental study using a within-subject design, we analyze two ways of trend prediction that have analogues in the real world: probability estimates and confidence intervals (quantile estimates). We find that, depending on the type of task, either underconfidence (in probability estimates) or overconfidence (in confidence intervals) can be observed in the same trend prediction setting based on the same information. Furthermore, we find that the degree of overconfidence in both tasks is significantly positively correlated for all experimental subjects. These findings not only contribute to the literature on judgmental forecasting, but also have important implications for financial modeling. This paper demonstrates that a theorist has to be careful when deriving assumptions about the behavior of agents in financial markets from psychological findings.

Chasing trends: recursive moving average trading rules and internet stocks

“…At the daily level, however, stock prices may be quite unpredictable and also highly volatile, as exemplified by Internet stocks. Therefore, generating accurate forecasts from past price histories may be challenging, even for professional traders (see, e.g., Glaser et al, 2003). Nonetheless, some investors will naively extrapolate trends in the belief that the momentum can be exploited.…”

Does expertise influence the impact of overconfidence on judgment, valuation and investment decision?

“…Several studies document the fact that experts are prone to overconfidence (for example Russo & Schoemaker, 1992). Glaser, Langer, and Weber (2007) show that professional traders possess a higher degree of overconfidence than students but emphasize the fact that ''the question of the strength of professionals' biases compared to that of non-professionals is difficult to answer''.…”

Are All Professional Investors Sophisticated?

“…Institutional and individual investors channel money towards mutual funds that subsequently perform well (Keswani and Stolin, 2008). Institutional investors show more positive feedback herding than individual investors (Dennis and Strickland, 2002), professionals show more myopic loss aversion than students (Haigh and List, 2005) and professional traders can be more overconfident than students (Glaser et al, 2007). In contrast, there is less research that compares investment advisors with laymen, i.e.…”