Tuesday, February 14, 2012

Behavioral Finance and Sentiment/Tone Mining

There are two prominent claims about the stock market: one is that machines are driving the entire market these days. The other is that behavioral finance works and even sentiment-based trading can produce excess profits.

The very possibility that some traders are outperforming based on behavior-based analysis points to an interesting point. You commonly hear the claim that machines and algos drive the entire stock market these days (and perhaps other markets too). Although it is true that automated trading (including program trading (trading in baskets) and high-frequency trading) drive considerable volume, it does not necessarily follow that psychology is irrelevant. The market as it stands right now is neither an entirely agent-based market (where machines do all the decisionmaking and strategizing) nor human-psychology-based. It is a hybrid of the two. Trading has become much more systematic although some discretionary funds still exist.

IBM Research has a paper, Agent-Human Interactions in the Continuous Double Auction [PDF], on the subject in a more theoretical setting.

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