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Market Fluctuation


Without bear markets to take stock prices back down, anyone waiting to 'buy low' ... The charming child v.s. the sleepy aged. Pricing uncertainty using binominal trees ... – PowerPoint PPT presentation

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Title: Market Fluctuation

Market Fluctuation
  • Price Fluctuation
  • The Value of Uncertainty
  • The Way of Timing
  • The Way of Pricing

Fluctuation and Extreme Movement
  • Price volatility and Earnings volatility
  • Bull and bear markets 1949-1961 and 1990-2000
  • --Without bear markets to take stock prices back
    down, anyone waiting to buy low will feel
    completely left behind, and all too often will
    end up abandoning any former caution and jumping
    in with both feet
  • --The longer a bull market lasts, the more
    severely investors, who no longer believe bear
    markets are even possible, will be afflicted with

Extreme Movement
  • Point of inflection breakthrough
  • Mass psychology booms and crashes
  • The historical review of booms and crashes
  • Tulip bulb
  • Automobile
  • Aviation
  • Internet (Telecommunication)
  • Biotech

What Causes Price Fluctuation?
  • Expectation on future prospects
  • The driving force behind the demand curve and the
    supply curve
  • Price itself, market sentiment, fundamentals, and
    leverage effects
  • Stock price itself and earnings
  • Bond price itself and interest rates
  • Currency exchange rates and economic growth
  • Real estate real estate price and inflation
  • Commodities price itself and macroeconomic

The Value of Uncertainty
  • The charming child v.s. the sleepy aged
  • Pricing uncertainty using binominal trees
  • A simple example
  • Consider a firm that is trying to decide to
    invest a machine factory and
  • the factory can be built instantly at 1600
  • will produce one machine per year forever
    with zero operating cost.

The Value of Uncertainty
  • Currently, the price of a machine is 200, but
    next year the price will change.
  • With 50 of probability, it will rise to
    300, and with 50 of probability, it will fall
    to 100.
  • The price will then remain at this new level
  • Assume that the firm should discount future
    cash flows using the risk-free rates of 10.
  • Should the firm invest the machine?
  • If yes, should it invest now or should it wait
    for one year?

Calculation of Uncertainty Value
  • The expected net present value of investing now
  • The expected net present value of investing later
    (wait for one year to get more information)

Calculation of Uncertainty Value
  • The expected net present value of investing now
  • The expected net present value of investing later
  • The value of the option to defer (wait),
  • suggesting that the value of the right
  • that we have to invest one year later rather
    than right now is 173.
  • It is better to wait for one year than to invest
    right now

The Way of Timing
  • Speculators anticipate the action of the stock
  • Speculators buy and hold when the future course
    is deemed to be upward and sell and refrain
    buying when the future course is deemed to be
  • If an investor places his emphasis on timing, in
    the sense of forecasting, he will end up as a
    speculator and with a speculators financial

The Way of Timing
  • The stock brokers and the investment services
    seem wedded to the principle that investors and
    speculators should devote careful attention to
    market forecasts
  • Investors have been persuaded that they should
    form some opinion of the future course of the
    stock market and that brokerage or service
    forecast is at least more dependable than their

Speculators Timing Psychology
  • Timing is of great psychological importance to
    the speculator because he wants to make his
    profit in a hurry, since the idea of waiting one
    or two years before his stock moves up is
    repugnant to him
  • However, a waiting period is of no consequence to
    the investor, who enjoys an advantage only if by
    waiting he succeeds in buying later at a
    sufficiently lower price to offset his loss of
    dividend income

Speculators Timing Psychology
  • Why can any typical or average investor
    anticipate market movements more successfully
    than the general public, of which he is himself a
  • For who will buy when the general public, at a
    given signal, rushes to sell out at a profit (or
    a loss)?
  • The positive trading psychology of buying past
    winners and short selling past losers

The Timing Signals
  • Trading volume relative to price movement
  • Advancing stocks relative to declining stocks
  • Margin trade relative to short selling
  • Insider trading activities
  • Trading activities of institutional investors
  • Stock repurchase activities
  • Initial public offerings (IPO)
  • Stock seasoned issuance

The Timing Signals
  • Mass media signals
  • Price relative to earnings
  • Cash dividends relative to price
  • Book value relative to price
  • Government intervention
  • Derivative trading activities

The Way of Pricing
  • Investors buy stocks when they are quoted below
    their fair (intrinsic) value and sell when they
    rise above such value
  • Make sure that you do not pay too much for your
    stocks when you buy
  • Make tactical asset allocation when the levels of
    stock prices appear more or less attractive by
    value standard

Discrepancy between Value and Price
  • Mr. Market
  • - Mass psychology
  • - Fear and greed
  • Calculate a firms fair (intrinsic) value
  • - Expected future cash flows
  • - Estimated risk discounted rate
  • - Probabilistic decision making
  • - Mood of Mr. Market

The Role of Security Selection
  • In efficient markets, active portfolio
    management, like market timing, tends to detract
    from aggregate investment performance.
  • In the context of relative performance to the
    market index return, security selection
    constitutes a zero-sum game.
  • In the aggregate, active investors will lose by
    the amount it costs to play the game in the form
    of transaction costs, fees, and market impact.

Effective Security Selection
  • Value-oriented strategies in inefficient markets
  • Value can be purchased by identifying assets
    trading below fair value, or created by bringing
    unusual skills to improve corporate operations
  • Value investors operate with a margin of safety
    unavailable to less conservative investors
  • Thinly-traded, illiquid, neglected, and
    small-size private equity