On the trend recognition and forecasting ability of professional traders

Markus Glaser (), Thomas Langer () and Martin Weber
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Markus Glaser: Sonderforschungsbereich 504, Postal: L 13, 15, D-68131 Mannheim
Thomas Langer: Westfälischen Wilhelms-Universität Münster Lehrstuhl für BWL, insbesondere Finanzierung, Postal: Universitätsstraße 14-16 48143 Münster

No 03-06, Sonderforschungsbereich 504 Publications from Sonderforschungsbereich 504, Universität Mannheim, Sonderforschungsbereich 504, University of Mannheim

Abstract: Empirical research documents that temporary trends in stock price movements exist. Moreover, riding a trend can be a profitable investment strategy. Thus, the ability to recognize trends in stock markets influences the quality of investment decisions. 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 and novices (MBA students). In an experimental study, we analyze two ways of trend prediction: probability estimates and confidence intervals. Subjects observe stock price charts, which are artificially generated by either a process with positive or negative trend and are asked to provide subjective probability estimates for the trend. In addition, the subjects were asked to state confidence intervals for the development of the chart in the future. 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. Underconfidence in probability estimates is the more pronounced the longer the price history observed by subjects and the higher the discriminability of the price path generating processes. Furthermore, we find that the degree of overconfidence in both tasks is significantly positively correlated for all experimental subjects whereas performance measures are not. Our study has important implications for financial modelling. We argue that the question which psychological bias should be incorporated into a model does not depend on a specific informational setting but solely on the specific task considered. This paper demonstrates that a theorist has to be careful when deriving assumptions about the behavior of agents in financial markets from psychological findings.

Pages: 32 pages
Date: 2003-04-16
New Economics Papers: this item is included in nep-fin
Note: Financial support from the Deutsche Forschungsgemeinschaft, SFB 504, at the University of Mannheim, is gratefully acknowledged.
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Related works:
Journal Article: On the Trend Recognition and Forecasting Ability of Professional Traders (2007)
Working Paper: On the Trend Recognition and Forecasting Ability of Professional Traders (2003)
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