Tuesday, July 18, 2006

Return from Overseas

MelbournePhilosopher

I've been overseas for the past month, during which I paid some attention to the stockmarket but didn't really do much on the blog or self-education front.

However, the times have been volatile, so I've had a little education thrust upon me :). One thing which I was interested in was the amount of psychology present in the market. Let's say that that the price of a share is the sum of two components -- one a function of "value" and the other a function of "psychology". Let us suppose that the value of a share is drawn from the company's /fundamentals/ -- that is to say, the dividends paid, income earned, operating profit and other business metrics. Let us suppose that whatever is left after accounting for this is the result of psychology -- and let's just think of this as a term for any reaction to share price changes which is *not* justified by the fundamentals.

How big is the value component, and how big is the psychological component?

It seems to me like this question does have an answer. Let's suppose that there is some point in time (let's say, August last year) where the share price was dominated by the fundamental component, and there was not much psychology at play. The psychological component then can be measured if the share price changes while the fundamentals do not.

I don't, as of right now, have a method for determining actual numbers for these components. However, I find it a useful distinction nonetheless. One sees the interplay most clearly during periods of quiet, where there is no news on the company in question, nor any market-wide shock, yet the share price changes. Can this change be attributed to anything other than psychology?

Looking at ENG over a year, the price climbed quickly from 8c to 48c, on the strength of both its fundamentals and general market optimism (i.e. in line with market-general psychology). Recently, it fell to around 25c, without the fundamentals having changed significantly. (In fact it could be argued that they improved). Presumably, then, at 48c there was about (say) 22c of fundamental value, and about 26c of psychological value. That is to say, about half.

I will attempt to think further on this to work out if some better analysis could be achieved. However, it is useful to me as it helps me crystallise my thoughts on /how much importance/ to place on techniques of fundamental analysis vs techniques of chart/technical/psychological analysis.

All things to wonder about. Feedback welcome -- today's post is very speculative.

Cheers,
-MP

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