| Just as it is important that networks for
| |
| | that financial markets are efficient.
|
| transport, electricity and
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| | According to the efficient market
|
| telecommunications function properly, so
| |
| | hypothesis (EMH), only changes in
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| is it essential that, for example,
| |
| | fundamental factors, such as profits or
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| payments can be transacted, capital can
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| | dividends, ought to affect share prices.
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| be saved and channeled to the most
| |
| | (But this largely theoretic academic
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| profitable investment projects and that
| |
| | viewpoint also predicts that little or no
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| both households and firms get help in
| |
| | trading should take place— contrary to
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| handling financial uncertainty and risk
| |
| | fact— since prices are already at or
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| as well as possibilities of spreading
| |
| | near equilibrium, having priced in all
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| consumption over time. Financial markets
| |
| | public knowledge.) But the
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| constitute an important part of the total
| |
| | efficient-market hypothesis is sorely
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| infrastructure for every society that has
| |
| | tested by such events as the stock market
|
| passed the stage of largely domestic
| |
| | crash in 1987, when the Dow Jones index
|
| economies.
| |
| | plummeted 22.6 per cent— the
|
| The financial system performs three main
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| | largest-ever one-day fall in the United
|
| tasks: first, it handles transfer of
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| | States. (However, this was part of a
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| payments; second, it channels savings to
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| | world-wide crash of stock markets which
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| investments with a good return for future
| |
| | did not originate in the US.) This event
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| consumption; and third, it spreads and
| |
| | demonstrated that share prices can fall
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| reduces (local enterprise) economic risks
| |
| | dramatically even though, to this day, it
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| in relation to the players' targeted
| |
| | is impossible to fix a definite cause: a
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| returns (but note that systemic risk is
| |
| | thorough search failed to detect any
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| not thereby reduced— it merely becomes
| |
| | specific or unexpected development that
|
| less concentrated and uneven). Moreover,
| |
| | might account for the crash. It also
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| unforeseen risks, or catastrophic risks
| |
| | seems to be the case more generally that
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| (such as the complete collapse of the
| |
| | many price movements are not occasioned
|
| financial system or government
| |
| | by new information; a study of the fifty
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| institutions), may not be capable of
| |
| | largest one-day share price movements in
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| being spread, or insured against.
| |
| | the United States in the post-war period
|
| The smooth functioning of all these
| |
| | confirms this.[2] Moreover, while the EMH
|
| activities facilitates economic growth in
| |
| | predicts that all price movement (in the
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| that lower costs and enterprise risks
| |
| | absence of change in fundamental
|
| promote the production of goods and
| |
| | information) is random (i.e.,
|
| services as well as employment. In this
| |
| | non-trending), many studies have shown a
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| way the financial system contributes to
| |
| | marked tendency for the stock market to
|
| increased prosperity.
| |
| | trend over time periods of weeks or
|
| The stock market is one of the most
| |
| | longer.
|
| important sources for companies to raise
| |
| | Various explanations for large price
|
| money. Experience has shown that the
| |
| | movements have been promulgated. For
|
| price of shares and other assets is an
| |
| | instance, some research has shown that
|
| important part of the dynamics of
| |
| | changes in estimated risk, and the use of
|
| economic growth. Rising share prices, for
| |
| | certain strategies, such as stop-loss
|
| instance, tend to be associated with
| |
| | limits and Value at Risk limits,
|
| increased business investment and vice
| |
| | theoretically could cause financial
|
| versa. Share prices also affect the
| |
| | markets to overreact.
|
| wealth of households and their
| |
| | Other research has shown that
|
| consumption. Therefore, central banks
| |
| | psychological factors may result in
|
| tend to keep an Argus eye on the control
| |
| | exaggerated stock price movements.
|
| and behavior of the stock market and, in
| |
| | Psychological research has demonstrated
|
| general, on the smooth operation of
| |
| | that people are predisposed to 'seeing'
|
| financial system functions. Financial
| |
| | patterns, and often will perceive a
|
| stability is the raison d'etre of central
| |
| | pattern in what is, in fact, just noise.
|
| banks.
| |
| | (Something like seeing familiar shapes in
|
| Relation of the stock market to the
| |
| | clouds or ink blots.) In the present
|
| modern financial system The financial
| |
| | context this means that a succession of
|
| system in most western countries has
| |
| | good news items about a company may lead
|
| undergone a remarkable transformation.
| |
| | investors to overreact positively
|
| One feature of this development is
| |
| | (unjustifiably driving the price up). A
|
| disintermediation. A portion of the funds
| |
| | period of good returns also boosts the
|
| involved in saving and financing flows
| |
| | investor's self-confidence, reducing his
|
| directly to the financial markets instead
| |
| | (psychological) risk threshold.[3]
|
| of being routed via banks' traditional
| |
| | Another phenomenon— also from
|
| lending and deposit operations. The
| |
| | psychology— that works against an
|
| general public's heightened interest in
| |
| | objective assessment is group thinking.
|
| investing in the stock market, either
| |
| | As social animals, it is not easy to
|
| directly or through mutual funds, has
| |
| | stick to an opinion that differs markedly
|
| been an important component of this
| |
| | from that of a majority of the group. An
|
| process. Statistics show that in recent
| |
| | example with which you may be familiar is
|
| decades shares have made up an
| |
| | the reluctance to enter a restaurant that
|
| increasingly large proportion of
| |
| | is empty; people generally prefer to have
|
| households' financial assets in many
| |
| | their opinion validated by those of
|
| countries. In the 1970s, in Sweden,
| |
| | others in the group.
|
| deposit accounts and other very liquid
| |
| | In one paper the authors draw an analogy
|
| assets with little risk made up almost 60
| |
| | with gambling.[4] In normal times the
|
| per cent of households' financial wealth,
| |
| | market behaves like a game of roulette;
|
| as against less than 20 per cent in the
| |
| | the probabilities are known and largely
|
| 2000s. The major part of this adjustment
| |
| | independent of the investment decisions
|
| in financial portfolios has gone directly
| |
| | of the different players. In times of
|
| to shares but a good deal now takes the
| |
| | market stress, however, the game becomes
|
| form of various kinds of institutional
| |
| | more like poker (herding behavior takes
|
| investment for groups of individuals,
| |
| | over). The players now must give heavy
|
| e.g., pension funds, mutual funds, hedge
| |
| | weight to the psychology of other
|
| funds, insurance investment of premiums,
| |
| | investors and how they are likely to
|
| etc. The trend towards forms of saving
| |
| | react psychologically.
|
| with a higher risk has been accentuated
| |
| | We are also liable to succumb to biased
|
| by new rules for most funds and
| |
| | thinking. An example is when supporters
|
| insurance, permitting a higher proportion
| |
| | of a national football team (or a
|
| of shares to bonds.
| |
| | favorite stock), for instance, are
|
| Similar tendencies are to be found in
| |
| | overconfident about the chances of
|
| other industrialized countries. In all
| |
| | winning (or the stock moving up).
|
| developed economic systems, such as the
| |
| | The stock market, as any other business,
|
| European Union, the United States, Japan
| |
| | is quite unforgiving of amateurs.
|
| and other first world countries, the
| |
| | Inexperienced investors rarely get the
|
| trend has been the same: saving has moved
| |
| | assistance and support they need. In the
|
| away from traditional (government
| |
| | period running up to the recent Nasdaq
|
| insured) bank deposits to more risky
| |
| | crash, less than 1 per cent of the
|
| securities of one sort or another.
| |
| | analyst's recommendations had been to
|
| The stock market, individual investors,
| |
| | sell (and even during the 2000 - 2002
|
| and financial risk Riskier long-term
| |
| | crash, the average did not rise above
|
| saving requires that an individual
| |
| | 5%). The media amplified the general
|
| possess the ability to manage the
| |
| | euphoria, with reports of rapidly rising
|
| associated increased risks.
| |
| | share prices and the notion that large
|
| Stock prices fluctuate widely, in marked
| |
| | sums of money could be quickly earned in
|
| contrast to the stability of (government
| |
| | the so-called new economy stock market.
|
| insured) bank deposits or bonds. This is
| |
| | (And later amplified the gloom which
|
| something that could affect not only the
| |
| | descended during the 2000 - 2002 crash,
|
| individual investor or household, but
| |
| | so that by summer of 2002, predictions of
|
| also the economy on a large scale. The
| |
| | a DOW average below 5000 were quite
|
| following deals with some of the risks of
| |
| | common.) Irrational behavior Because a
|
| the financial sector in general and the
| |
| | considerable part of the stock market is
|
| stock market in particular. This is
| |
| | comprised of non-professional investors,
|
| certainly more important now that so many
| |
| | sometimes the market tends to react
|
| newcomers have entered the stock market,
| |
| | irrationally to economic news, even if
|
| or have acquired other 'risky'
| |
| | that news has no real effect on the
|
| investments (such as 'investment'
| |
| | technical value of securities itself.
|
| property, i.e., real estate and
| |
| | Therefore, the stock market can be swayed
|
| collectables).
| |
| | tremendously in either direction by press
|
| With each passing year, the noise level
| |
| | releases, rumors and mass panic.
|
| in the stock market rises. Television
| |
| | Furthermore, the stock market is
|
| commentators, financial writers,
| |
| | comprised of a large amount of
|
| analysts, and market strategists are all
| |
| | speculative analysts, or pencil pushers,
|
| overtalking each other to get investors'
| |
| | whom have no substantial money or
|
| attention. At the same time, individual
| |
| | financial interest in the market, but
|
| investors, immersed in chat rooms and
| |
| | make market predictions and suggestions
|
| message boards, are exchanging
| |
| | regardless. Over the short-term, stocks
|
| questionable and often misleading tips.
| |
| | and other securities can be battered or
|
| Yet, despite all this available
| |
| | buoyed by any number of fast
|
| information, investors find it
| |
| | market-changing events, turning the stock
|
| increasingly difficult to profit. Stock
| |
| | market in a generally dangerous and
|
| prices skyrocket with little reason, then
| |
| | difficult to predict environment for
|
| plummet just as quickly, and people who
| |
| | those people whose lack of financial
|
| have turned to investing for their
| |
| | investment skills and time does not
|
| children's education and their own
| |
| | permit reading the technical signs of the
|
| retirement become frightened. Sometimes
| |
| | market.
|
| there appears to be no rhyme or reason to
| |
| | Conclusion There have been innumerable
|
| the market, only folly.
| |
| | recommendations about how to make the
|
| This is a quote from the preface to a
| |
| | stock market easier and safer for the
|
| published biography about the well-known
| |
| | casual, non-professional investor. Few,
|
| and long term value oriented stock
| |
| | if any, are likely to prove useful or
|
| investor Warren Buffett.[1] Buffett began
| |
| | effective. However, in order to minimize
|
| his career with only 100 U.S.
| |
| | the risks of financial market imbalances,
|
| dollars and has over the years built
| |
| | it is important that there be a well
|
| himself a multibillion-dollar fortune.
| |
| | thought-out legislative, regulatory, and
|
| The quote illustrates something of what
| |
| | supervisory infrastructure that functions
|
| has been going on in the stock market
| |
| | properly, smoothly, and honestly. This is
|
| during the end of the 20th century and
| |
| | a never-ending task that requires the
|
| the beginning of the 21st.
| |
| | participation of all concerned.
|
| The behavior of the stock market From
| |
| | Today, average individuals face sometimes
|
| experience we know that investors may
| |
| | very difficult risk management decisions
|
| temporarily pull financial prices away
| |
| | that were not required of previous
|
| from their long term trend level.
| |
| | generations. Both opportunities and risks
|
| Over-reactions may occur— so that
| |
| | for the individual investor have been
|
| excessive optimism (euphoria) may drive
| |
| | amplified many times over. Yet the
|
| prices unduly high or excessive pessimism
| |
| | average investor still lacks the relevant
|
| may drive prices unduly low.
| |
| | knowledge. Everyone cannot be a
|
| New theoretical and empirical arguments
| |
| | specialist in risk management and
|
| have been put forward against the notion
| |
| | financial theory.
|
