How Market Traders Make Decisions To Trade
There are quite a number of factors that a traders which includes short and long term investors, speculators, fund managers and also those who buy and sell in the stock markets need to be taken in to consideration before making decisions to trade in the investment market whether it's in the stocks or commodities trading markets. Those factors are fundamental, technical or market sentiments. These 3 types also known as Fundamental, Statistical and Macroeconomics.
The main objective of this research is to find out whether those fundamental, statistical and macroeconomics factors influence investors, traders and fund managers decision on stock and commodities portfolio management. Besides, is also to find out how those factors influence the traders decisions making. And also determine to what extend those factors influences the traders decisions.
In a fund management, the equity or commodities portfolio management require fund managers to make decisions about what portfolio to hold in order to gain returns. As the future returns are uncertain, market participants try to understand the nature of the uncertainty and make decisions based on their beliefs about the market environment.
In early years, investors based on fundamental approach to make decision and used financial statements to find the value of the shares. As the time progressed this method became very important in the investment field. It was generally advocated the use of different ratios for this purpose and strongly supported the use of financial ratios to know the worth of the investment. The proposed type of analysis later on became the common-size of analysis. (Project Guru, n.d.)
Besides, fundamental approach, there is also macroeconomic or market sentiments approach or method been used, whereas it was based on the factors such as political, economics, interest rate and etc.
The other major method adopted was the study of stock price movement with the help of price charts. This method later on was known as Technical Analysis. It evolved during 1900-1902 when Charles H. Dow, the founder of the Dow Jones and Co. presented his view in the series of editorials in the Wall Street Journal in USA. The advocates of technical analysis believed that stock prices movement is ordered and systematic and the definite pattern could be identified. There investment strategy was build around the identification of the trend and pattern in the stock price movement. There is also another prominent author who supported technical analysis was Ralph N. Elliot who published a book in the year 1938 titled ―The Wave Principle. After analyzing 75 years data of share price, he concluded that the market movement was quite orderly and followed a pattern of waves. His theory is known as Elliot Wave Theory. (Project Guru, n.d.)
Traditionally, the standard practise of portfolio managers used mean-variance analysis to determine the optimal portfolio to hold. This means-variance analysis is based on the historical data. Mean-variance portfolio decision models fall in the more general group of mean-risk models, where portfolio risk and expected return are traded-off when making asset choices.
There are three main types of multi-factor models.
Macroeconomic models use economic variables as factors. This factor also known as market sentiments and situations factors. It mostly based on external influences, making decisions based on relationship between equity prices and the economic environment. Besides, there are also typical factors such as unexpected changes in inflation, changes in oil prices, returns in the bond market, political situation of the country and others. These factors are observable time series.
Fundamental factors use firm specific attributes which are not related to the economic environment and sentiments. These included factors based on the firm’s structure, eg the firm size, profit yield, dividend yield, industry classification and all the accounting figures. . The factor realisations are derived through cross-sectional regression or from returns on portfolios based on the observed asset characteristics known as single factor (also factor mimicking) portfolios.
In Statistical model which also known as technical factor, the factors of realisations and exposures are unobservable. The factor exposures are estimated in this process. Methods used for calibration of these models include maximum likelihood factor analysis and principal components analysis.
Statistical models use historical correlations to determine a set of orthogonal factors. The advantage of this is that they can evolve over time to pick up new conditions without the need to identify changes in the factor structure. However these factor are opaque and it is difficult to identify them with interpretable sources of risk. When identifying the statistical factor together with fundamental stock attributes is often give disadvantage to the Statistical models. This factors are observe based more on technical analysis with chart and technical indicator for determination.
The variables to test whether the market sentiments affects the market traders reaction is political condition of the country, economic conditions, interest rates and other marcroeconomic variables. Besides, the variables for technical analysis are whether investors, traders, fund managers does use technical analysis to determine their decision to enter market. The variables for fundamental factors are such as higher earning results with higher price earning ratio, better dividend policy and etc.
The focus of the present research is to investigate the relationship between news sentiments and market volatility of market capitalisation asset prices. As security and market volatility vary over the time as situations change and new information becomes available to traders. Option traders respond quickly to new information that impacts expectations of future volatility because option prices are directly dependent on such volatility expectations. Besides, the research will also study the impact of information releases on market level uncertainty on interest rate and foreign exchange futures markets towards the traders decisions. Furthermore, is to investigate whether traders or fund managers are dependent on technical analysis by finding out whether they did use technical analysis as decision making factors. In addition, to find out whether fundamental is also known as accounting figures such as release of financial statement and dividend announcement does affect the traders decision by observing the price.
All this can be investigated by comparing performance of different mutual funds with those factors. Besides, it can also compare the return of a mutual fund using different investment ways. By comparing the different portfolios being maintained by selected fund managers approaches.
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