Sunday, February 3, 2013

Book Review: Psychology and the Stock Market

Psychology and the Stock Market (1977) by David N. Dreman

Even though it was published over 35 years ago, this book provides a good overview of the role that psychology plays in the stock market. Part I addresses the poor performance of professional investors and the rise and fall of technical analysis. Part II takes a look at various bubbles and manias that have occurred throughout stock market history, showing that they tend to have common characteristics. Part III delves into the psychology behind the poor performance and bubbles by discussing the follies of groupthink, which is the lack of independent critical thinking among many investors that leads to herd-like behaviors such as panic selling. I appreciated how the author drew upon a great deal of social psychology research to support his groupthink idea. Part IV deals with the efficient market hypothesis (EMH) and the question of whether an investor can beat the market. It provides one of the most compelling counterarguments to EMH that I have ever read, highlighting psychological evidence that destroys EMH assumptions about investors being completely rational, informed, and unbiased in their decision-making. Believers in EMH should find themselves questioning their beliefs after reading this book.

Note: I read this book in November 2012.

8 comments:

  1. Sounds like an interesting book. I'm always interested in how psychology plays into investing in stocks. To me the most interesting thing is how what is best for investors is to invest when stock prices are low (have fallen alot recently) and sell out or hold when prices are high (have had a large run up). But psychologically that is the hardest thing to do but is what must be done to have the most success! Because it is so hard to do I think most active investors fail over the long term compared to those passive investors who are committed to dollar cost averaging each month when they have money available and without really taking into account what the market is doing.

    ReplyDelete
    Replies
    1. Dan: Thanks for your comment. I agree that it can be difficult to buy low and sell high. It requires a lot of patience, discipline, and rational thinking, as well as a long-term view of investing.

      After reading this book I read the latest one from Dreman, which was published in 2012 and is entitled "Contrarian Investment Strategies: The Psychological Edge." It's a great book that I will be reviewing soon (I'm a bit behind on my book reviews).

      Delete
  2. Interesting point on EMH. It reminds me of Buffet's comment that the market is a voting machine in the short term and a weighing machine in the long term. I tend to think that EMH needs to be looked at with a time horizon. In the short term, markets struggle with EMH. They grossly over or undercorrect to good/bad news. In the long term, markets tend to be fairly good at calibrating based on available information.

    ReplyDelete
    Replies
    1. Integrator: I agree about the short vs. long term distinction. Even thought the market may react quickly to news, the initial reaction may be inaccurate. It is only after some time has passed that the market calibrates itself more appropriately. EMH doesn't really make that distinction (it assumes perfect, instantaneous reactions), which I regard as one of its weaknesses.

      Delete
  3. DGM,

    A belated congratulations on the new job! If you don't mind me asking, what field are you working in? I have a PhD in biochemistry, but left academia for the biopharm industry a few years ago.

    ReplyDelete
    Replies
    1. Big J: Thanks! To answer your question, I work in psychology, but not the clinical/counseling side.

      Delete
  4. I would like to appreciate your efforts that bring really nice work and also engage all people here to take opportunity for share their views. This is truly nice.

    ReplyDelete
    Replies
    1. Multibagger: Thanks, I appreciate the feedback!

      Delete