INDICATORS
Similar But Different
True Price Value
by Daryl Guppy and Chen Jing
What is more important in determining market behavior and market pricing, fair value based on fundamentals or the market value created by psychological trading behavior?The classic economic and market models rest on fair value and describe pricing activity in the market as subject to "irrational exuberance." An analysis of the China and Hong Kong markets with a parallel listing of China-based companies suggest that psychological trading behavior has a much greater role to play in correct market pricing. The study suggests that the market price is the rational and valid price and acknowledges an emotional component in pricing. This confirms the role that technical analysis plays in understanding market behavior and making sound trading and investment decisions.
The variety and difference in trend behavior in these parallel listed stocks challenge many assumptions about the relationship between price, value, fair pricing, and the extent of the role of emotional behavior in setting enduring price relationships.
FUNDAMENTAL OR TECHNICAL?
Many traders believe financial markets are a fabrication where the price of a traded stock is driven primarily by the emotions and behavior of participants. These traders make profits by understanding the psychology of the market and using charting and technical analysis methods to identify points of trend change or trend continuation.
In comparison, many investors believe the market is about fundamental value based on the real business and performance of the company. When the traded price moves above or below this true value, the investors lament the distortions introduced by market emotions and overreactions. They view the market as rational or irrational, forgetting that even the most excited person believes he is making a rational decision to buy. Their investment technique often rests on locating companies trading below their true value on the assumption that the market price will eventually lift to match and reflect the true value.
Each of these belief systems has developed successful trading and investing strategies and mythology. Traders who use technical analysis and charting methods have become accustomed to criticism from fundamentalists. It is difficult to respond because it is not easy to isolate the psychological component in price discovery, or to show how pricing is largely driven by behavioral and emotional factors.
...Continued in the April issue of Technical Analysis of STOCKS & COMMODITIES
Excerpted from an article originally published in the April 2008 issue of Technical Analysis of
STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2008, Technical Analysis, Inc.
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