Trading The Trend - The Madness Of Crowds

18th Dec '20 by Michael Taylor

21 comments 3770 reads

It is scary how quickly this year has gone. It only feels like yesterday the entire equity market was collapsing and supermarkets were (bizarrely) being emptied of toilet roll.

There is a fantastic book called The Extraordinary Popular Delusions and the Madness of Crowds. It was first published in 1841 so archaic in language but offers insights into how people react and think.

The truth is that people are not rational and are often incapable of making decisions in their own best interests.

For example, let’s say I am offered £200 by a third party and told that if I share it with someone and they accept then we can both keep the full £200 between us. If the other person doesn’t accept, then nobody keeps the money.

You might expect that because I am fair I would offer you £100 and keep £100 for myself. If you say yes, then we both keep the £100.

But I have studied economics. The economic argument would be to keep £199.99 for myself and offer you £0.01. This is because you would be one penny better off than if you did not have the penny. Therefore, under this argument you would accept my offer because this is clearly in your own best interests.

However, it turns out I am generous and have decided to offer you £5. I will keep £195 which I will book a nice spa hotel for my wife and I. You can buy a flat white and keep the change.

Do you accept?

Possibly not! Despite you being a whole £5 better off – the unfairness of it stinks and it’s possible that you want me to miss out of the money as a result out of spite.

This goes against all economic theory. But that’s the problem with economics. It assumes that there are no emotions. No greed or jealousy, no fear of missing out, no comfort in doing what everyone else is doing and no being scared of acting outside of the herd.

What does this mean for stocks?

The market is slow to change its opinion. It lags change, and presents opportunities.

I remember something Paul Scott once said at a Mello presentation: “The ability to change your mind when the facts materially change is a key factor of outperformance” – or something similar! He…

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The Phoenix

18th Dec '20

Reading between the lines Michael will you not be returning with a weekly column next year would be a shame if that's not the case.

wmullen

Thanks for all the articles Michael, they have made very interesting reading!

Just wondering about your opinion on systematic trend trading? Is this something you have dabbled in yourself or intend looking into in the future? Seems like there are some good open source platforms now for getting into that space (e.g zipline)

johnsmith68

Thanks Michael, I lost all patience with £FA and concluded that their ticker symbol was a forecast of what investors would be left with!

The article you linked to with Gervais William's comments were interesting but I did a simple stock screen for a financial company with a market cap between £400m - £600m and couldn't come with anything remotely close to the P/E ratio he cited. None of the resulting companies had Premier Miton listed as shareholders. Do you know of somewhere where one can look to see recent purchases buy particular funds, or a way to search RNS news feeds to find recent purchases?

William K

Many thanks for all your articles and insights over the last year, Michael.

ceejay9

There is a branch of mathematics which includes 'the madness of crowds' as a special case. It is called 'emergent properties', i.e the property of a 'crowd' emerges from the properties (behaviour) of individuals. I wrote a simulation of the behaviour of a flock of birds. When you assume that birds follow the one directly in front the outcome is something like a murmuration. If birds follow the one diagonally in front (some birds have eyes on side of their heads) the outcome is a V shaped skein - like geese. The stock market is an emergent property from the behaviour of individuals, but all my attempts to model it come down to random walks. Sorry, that's no help at all!

cbeamer83

Thanks Michael for all your commentary this year. I've found it extremely useful. I hope we continue to see you elsewhere. All the best for trading in 2021.

Gdawgeedawg

Hi John, I believe that they are listed as Premier Asset Management Ltd. E.g. Brighton Pier has them listed as major shareholders.

Harry Hindsight

19th Dec '20

Thanks Michael. As a past furlough starter I need to pattern trade to make up a pile so can go long eventually. I will take up your course at some point when have the time to give it full attention.

ISAallowance

Could be Just (LON:JUST) - about £650m mkt cap now and 4.5 p/e but £500m and 3.2 p/e would fit in October. Haven't looked at the shareholder register.

Gromley

20th Dec '20

Interesting observations about the sharing of £200 Michael.

I do not however agree that if you offered me 1p so that you could keep the £199.99.

The argument that if I reject he 1p I get nothing does not stack up in most circumstances.

If I reject 1p , I lose 1p - you on the other hand would lose £199.99.

I don' think I would blink first in that negotiation.

In fact if I knew that you were more in need of cash than me (as is often the case when companies are in discussions with their banks) then I would probably be pushing form me to get 199.99 and let you have 0.01.

If there were other players offering to deal with you, then of course I might get driven away from the "obvious" middle ground of a 50-50 split.

Negotiations are about the balance of power and need - in theory you should not enter a negotiation until you understand the balance of power.

Michael Taylor

Thank you Kevin. The only place I'll definitely be continuing to write is at IC and my own site.

With everything that has been going on this year at some points I've been writing when I should've been trading!

I'll still be around on Stockopedia in the comments of others' articles.

Hi clarea - as much as I enjoy writing at some points I've not been as focused as I should've been. As I mentioned to Kevin below, I'll still be around on Stockopedia just not with a column.

Hi John - that's understandable. I think in my whole trading career I've only ever known the stock as a pooch. I don't want to say it could be changing but there are a few green shoots which the market may've ignored so far.

You only need to register as a notifiable holder if you're above 3% - so it's possible Gervais is still below the minimum threshold.

I don't know how to do those searches I'm afraid - sorry I can't be more help.

Thank you wmullen.

I intend to look into algorithmic and automated trading at some point yes. To do that I'd need a lot more time than I have at the moment - but it's slowly creeping up on the priorities list.

My execution is 100% discretionary and I'd like to diversify some of that into automated execution in the future.

Have you researched or explored much in that area?

Thank you Wilkonz.

Which timeframe were you modelling? Trends do exist so it should be possible to model something that isn't a random walk, no? I have no experience in this area though so I could also be talking nonsense!

Thank you cbeamer - I'm delighted to hear that. I'll be around in the SCVR!

I think 2021 has the potential to be another vintage year in the market so here's to a cracking one for both of us.

Hi Gromley - you are right if this was a negotiation. Nobody accepts the first offer, unless you are a sucker.

In a negotiation, the price would be bartered to a point where both individuals feel that the gain outweighs the risk of loss on both sides.

I'm certain this would not be £0.01 - and assuming no other information on players it is likely the agreeable point would be around an equal split of £100 / £100.

As you say, depending on situations and how desperate each person seems, the price will vary accordingly.

£100 would be my intended goal because I'd believe it was the point where you'd also see it as fair and likely to accept.

Naturally, I'd offer you less at first (but not too low as giving back so much increases suspicion and reduces the likelihood of a deal being reached) and concede a few points before firming a take or leave at £100.

However, if there was no negotiation whatsoever, and it was one offer and a simple yes or no answer, then faced with being offered 1p and offered 0p the logical decision is to accept the 1p.

There is no reason to not do so unless you want to stop me from getting £199.99. But that would be harming yourself to harm me further.

Was it Interserve where equity holders lost everything because they refused to approve an equity placing? The option was to be reduced into oblivion - but still have something - or lose everything.

JCPr

Sorry to see the end of your columns. I'm not a trader but I've still found them interesting and thought provoking. Thanks and Good Luck.

I'm a coder by day and a Minnervini/Weinstein trader by night, so the barrier to entry for me is a little bit lower with regards to the coding than perhaps other people. I intend to use the quiet Xmas period to dip my toes in the water!

Trading the Trend - the madness of crowds

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Michael Taylor

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