Understanding behavioural influences on financial markets – fear, greed and everything in between!

Wealth Management and Private Banking

21 April 2016

Wealth Management and Private Banking

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Sponsor Introducing: Eric Lonergan, M&G
Facilitator: Annie Catchpole, Scorpio Partnership

Key message

News is not the only influencer on market price movements, with human behaviour also having a role to play in swaying price. If done correctly, identifying behavioural influences and differentiating it from fundamental price action can be used to generate investment gains for clients.


  • Behavioural influences exist in financial markets and can be exploited
  • Team size and experience are key in identifying and trading upon behavioural influences
  • Understanding market behaviours can be translated to private client behaviour 

Key themes

Anyone can pick up one of the many publications delving into the field of human behavioural influence on the markets, and while they can describe what we do and why, they do not prescribe how this knowledge can be utilised in the financial markets to generate returns.

Trading on behavioural influences is based on the premise that price is not only driven by news itself, but also by how investors react to news. For example, if tomorrow there was no news, the likelihood would be that prices would continue to fluctuate and not remain static. So what would be driving this? Behavioural influences. (In fact the lack of news would likely spread panic possibly driving prices down- no news would certainly be good news to a short seller!)

Fundamentally, there is a reason why stocks finish up or down on a given day. While news and information provided to the market input into price fluctuations, these events also change beliefs of the market which can over-emphasise or under-emphasise their value. A recent example of the Chinese “Black Monday” was given, where on the following day JP Morgan stocks on the S&P 500 fell circa 20%. It was argued that investors’ fear of volatility in the market was the reason that such a large and globally diverse institution was so affected by the news.

In terms of time periods, windows of positions generally are in the region of 6 months. However there can be “major events” in the markets that create such deeply entrenched behaviour that it can take five or even ten years to correct.

While delegates agreed that investor sentiment was certainly responsible for price fluctuations in the market, trading on this knowledge is easier said than done. Along with the intellectual capital of understanding investment biases, the size and structure of a behavioural finance team is immensely important to achieve success; too small and you may fall victim to the individual behaviours that you are trying to identify and too large, you may become the market itself and lose any potential cutting edge.

It was questioned why teams were necessary at all, with one delegate suggesting that a computer using algorithms may remove the individual biases that can tarnish this approach. However, a shortfall in using machine over man was that shifts in regimes (such as inflation rates) that could fundamentally shift market sentiment would be difficult to capture in a model – creating a potentially vast downside exposure.

It was stressed that attempting to profit on behaviour trends using this technique would never be performed at individual institution level. Trading at market level is preferable (country or segment were identified), mainly to remove any unforeseen fundamental reasons for a single holding that may look like behavioural influence. 

Finally, understanding of market behaviours can also be transferred to better understand client behaviours. The issue of “mob mentality” when it comes to clients reacting in mass to news in the markets was a highlighted issue, and it was proposed that a number of best practices may be utilised to limit behavioural impact: 

“It’s important to be on the front foot”, calling clients frequently and before mob mentality takes hold

  1.    Spending enough time educating and repeating to clients about the investment process and the philosophy that goes into it
  2.    Being transparent with clients and focussing on the long term goals of the investment and not the short term situation         


  • It appears that behavioural traits or “market sentiment” are priced into securities, and in light of this, there are potential gains to be made in distinguishing between fundamental and behavioural input in price.
  • However, distinguishing between the two can be difficult, and relies on a team of highly specialised professionals.
  • Understanding how behaviours impact in the financial markets, can in turn help form a greater understanding of what drives clients to make specific buy and sell decisions.