Investment opportunities during stock price bubbles
INVESTMENT OPPORTUNITIES DURING STOCK PRICE BUBBLES
Table of contents
1. Introduction……………………………………………………………………………………
2. The movements of stock prices………………………………………………………………..
3. The existence of stock price bubbles…………………………………………………………..
4. The limitations to arbitrage…………………………………………………………………….
5. Heterogeneities among rational arbitrageurs................................................................................
6. Stock bubble trading and exit strategies………………………………………………………...
7. Conclusion………………………………………………………………………………………
References……………………………………………………………………………………….
1. Introduction
Interesting thoughts have been released on how investors should trade with stock movements. The dynamics of modern trading strategies are primarily based on one of the most important studies ever written in financial management: Technical analysis on stock trends by Robert D. Edwards and John Magee. Their work emphasized techniques that could be used to identify stock patterns in order to predict future stock prices. The introduction of technical analysis went beyond fundamental analysis that focused completely on financial statement analysis. One of the implications of the new method implied that stock prices moved within a certain range around its true, fundamental value. This concept introduced a totally new trading strategy to financial markets: it became possible to (irrationally) speculate on stock prices, in other words: even when rational investors knew that stock prices were above their fundamental values, it could still be attractive to ‘trade with the stock’, as long as they believed that the prices would grow further.
The situation where a rapid expansion of the stock price is being followed by a sharp decline, while the fundamental value remains unchanged, is called an (economic) bubble. As we will show,
Table of contents
1. Introduction……………………………………………………………………………………
2. The movements of stock prices………………………………………………………………..
3. The existence of stock price bubbles…………………………………………………………..
4. The limitations to arbitrage…………………………………………………………………….
5. Heterogeneities among rational arbitrageurs................................................................................
6. Stock bubble trading and exit strategies………………………………………………………...
7. Conclusion………………………………………………………………………………………
References……………………………………………………………………………………….
1. Introduction
Interesting thoughts have been released on how investors should trade with stock movements. The dynamics of modern trading strategies are primarily based on one of the most important studies ever written in financial management: Technical analysis on stock trends by Robert D. Edwards and John Magee. Their work emphasized techniques that could be used to identify stock patterns in order to predict future stock prices. The introduction of technical analysis went beyond fundamental analysis that focused completely on financial statement analysis. One of the implications of the new method implied that stock prices moved within a certain range around its true, fundamental value. This concept introduced a totally new trading strategy to financial markets: it became possible to (irrationally) speculate on stock prices, in other words: even when rational investors knew that stock prices were above their fundamental values, it could still be attractive to ‘trade with the stock’, as long as they believed that the prices would grow further.
The situation where a rapid expansion of the stock price is being followed by a sharp decline, while the fundamental value remains unchanged, is called an (economic) bubble. As we will show,
References: 1) Abreu and Brunnermeier, 2003, Bubbles and Crashes, Econometrica 71, 173-204. 2) Brock, Lakonishok, LeBaron, 1992, Simple Technical Trading Rules and the Stochastic Properties of Stock Returns. The Journal of Finance 3) Brunnermeier and Nagel, 2004, Hedge Funds and the Technology Bubble, Journal of Finance 59, 2013-2040 6) De Long, Shleifer, Summers and Waldmann, 1990b, Positive Feedback Investment Strategies and Destabilizing Rational Speculation, Journal of Finance 45, 379-395. 7) Dow and Gorton, 1994, Arbitrage chains, Journal of Finance 49, 819–849 8) Edwards and Magee, 1948, Technical analysis of stock trends, book & online pdf 9) Fama, 1965, The Behavior of Stock Market Prices, Journal of Business 38, 34-105. 10) Greenwood and Nagel, 2009, Inexperienced Investors and Bubbles, Journal of Financial Economics 93, 239-258. 13) Shleifer and Vishny, 1997, The Limits of Arbitrage, Journal of Finance 52, 35-55. 14) Temin and Voth, 2004, Riding the South Sea Bubble, American Economic Review 94, 1654-1668.