Tag Archives: Profits

How Hedge Funds (Ab)use Human Psychology to Increase Profits

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I am a professional trader. That means that I buy and sell stocks for a living. And since I am a so-called ‘day trader’, the buying and selling have to happen within one day. This means that I am extremely short term focused: I try to anticipate where a stock will be at within five minutes or an hour from now, instead of five years.

As a trader, you obviously want to buy a stock as cheaply as possible, and to sell it for as much as possible. But if you think that studying financial documents and finding out what companies appear undervalued will help you in trading, you are only very partially right. Much more important, I dare to say, is understanding and using human psychology. And when you zoom in from years to days to minutes to seconds, the more important human psychology becomes.

Let me give you an example of how big hedge funds (which I certainly do not belong to) seem to use human psychology to increase their profits. I say ‘seem’, because I cannot prove this. If only because I don’t know who is buying or selling at any moment in time (but I can see what hedge funds own what stocks, and when they bought/sold). But given my everyday experience with movements in price, and applying common sense, I am reasonably certain.

Suppose there is a stock trading a little above $3. Last time it went to $3, it recovered to $10 within three years, and to $55 within six. Last year the stock was priced at $10, and ten years ago it was priced at $55. Therefore it looks cheap (irrespective of the fundamentals of the company). Hedge funds assume that many people are willing to buy at this price. Assume that many people do. Now hedge funds, with practically unlimited financial resources, come in. They create a level of resistance in the price. They do so by offering a practically infinite amount of stocks at best offer (being the lowest price at which people are willing to sell the stock: $3,21 in Table 1). By doing this, they create an upper limit in the price, since before the price can increase, all the stocks at best offer have to be bought, which is practically impossible given that the hedge funds have so much selling power compared to the rest.

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Table 1: order book of stock

 

Now, since the price cannot go up, it will go down at a certain point. Be it because of algorithms trying to maintain certain correlations with indices, or because the hedge funds actively sell stocks at successive levels of best bid (the highest price at which people are willing to buy the stock: 3,19, 3,18 etc. in Table 1). Through doing this, the price will decrease to let’s say $3: a ‘psychological level’ in the stock. Many of the people who bought the stock thought it would never go under $3. Now people get anxious. Then the hedge funds give the final blow, and push through the $3. Now people start to panic – “maybe the stock will go to $2!”. They start selling the stock ‘at market’, meaning regardless of the price.

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Figure 1: Arcelor Mittal stock

 

Now the hedge funds can buy the stock for less than $3 from the people who are selling at market, either to go ‘long’ (to have stocks), or to cover their shorts. See Figure 1 for a graphical display of this chain of events. Combine this with the fact that high frequency traders (acting on behalf of hedge funds) can change the order book in less than the blink of an eye (thereby changing the quantities on bid and offer), they can very quickly change the price of a stock. The price of a stock is after all nothing more than the price paid for the stock in the last transaction: so if you very quickly pull away successive levels of best bid, the next person selling at market will do so at a (much) lower price, meaning that the hedge funds buy at a lower price than the general public.

Now the hedge funds have bought their stocks, they pull back, and let the market do the rest.

 

Commercials: Not All Publicity is Good Publicity

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Commercials: you’re likely to absorb hundreds of them per day, via media such as the TV, radio and internet. As I have written about in a previous article, the average person spends 1/24 of his life watching commercials on television. That’s a quite a lot, isn’t it? But I don’t want to focus on this act of wasting our lives by consuming useless material. I want to take a look at the effect of commercials, and of marketing in general, on the perception of a company’s brand. Most companies seem to believe that any publicity is good publicity. They seem to think that – no matter how bad a commercial might be – it’s always better to have a commercial than to have no commercial at all. But the question is: is this true?

When you’re watching television, and you see a commercial of a brand you’ve never heard of before, what will be the effect of this commercial on your perception of the brand? Marketers seem to think that they’ve increased your ‘awareness‘ of their brand, in the sense that – consciously or not – you now know about the brand‘s existence. And this might very well be true. But then the question would be: is all awareness good awareness? Or can awareness – as created by commercials – lead to a (more) negative (instead of positive) perception of the brand by the customer?

I believe it can. I believe that whenever people see terribly non-funny commercials (as there are plenty of) on television, they associate the brand promoted in the commercial with negative values such neediness, pity and lameness. I believe that the next time these people are in front of, for example, a supermarket they’ve just seen in an utterly non-funny (but intended to be funny) commercial, they will think to themselves: ‘Come on, I’m not going to support such a quasi-funny company’, and they’ll decide to skip the store. Even though these people might have entered the store if they hadn’t watched the commercial, or if the company wouldn’t have produced the commercial in the first place. But now they’ve got all kinds of negative associations with the brand, they decide to skip the store and go to another store – which might have less awareness but still more positive awareness than the supermarket of the commercial. And this goes not only for the supermarket-market, but for any other kind of market as well.

Customers usually don’t care about whether a brand is well-known – note that this doesn’t hold for clothing brands and other products that depend for their value to a large extent on marketing. We just want to buy a particular good or a particular service. And the only thing guiding us to a particular store is our perception of this brand/store. And if this perception is negative – which it very likely might be as a result of a bad commercial – you’d consciously avoid this store, and move to a next one. Even though the particular brand might have put a lot of money into its marketing efforts, they’re worse off than they would have been if they hadn’t launched the commercial.

Of course, marketing – including commercials on television and radio – can have a positive effect on a company’s brand and consequently on the sales of the company’s goods/services. But only if the company markets the relevant aspects of its brand, and not just launches a commercial for the sake of showing how ‘funny’ it is as a supermarket. Most people won’t appreciate that: the intelligent people might feel like they’re being treated like babies, and will therefore consciously avoid the brand, and the less intelligent people might not respond at all to this irrelevant kind of commercials.

If want to get people to your store (or make use of your service), you have to stay close to the product your selling, because that’s where customers are coming for or not coming for. Emphasize your low prices, your current actions/sales or your great service, and skip the bullshit. Then, and only then, can marketing attract – instead of scare away – customers.

But what do you think?

Perspective on Renewable Energy from a Non-engineer or Physicist

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Let’s face it: we are going to run out of fossil fuels. Although the exact predictions might differ, there is little doubt that between 15 and 60 years from now our fossil fuel sources will be depleted. But that’s not our only problem: the water level is rising as well. A recent study shows that we can expect the water level to rise between 0,8 and 2 meters by 2100; more drastic predictions even talk about a rise of 7 meters (!) by the year of 2100.

We might not be alive any more by the year 2100, or much sooner for that matter: so why would we care? ‘Think about our children,’ is an argument often heard. ‘We have to leave the world behind in such manner that they have the same opportunities as we had.’ To be honest, I don’t think we should be too worried about our children’s destiny. Humanity has managed to do pretty well in coming up with all kinds of solutions for all kinds of problems, especially when we had to. Our children will do fine. But there might be another reason, next to an economical one, why we should focus on coming up with new sources of energy. And that reason is: we simply can, so why wouldn’t we try it? Also, it has to happen sooner or later, right? We can put our heads in the sand and hope the storm will pass by, but that isn’t going to solve the problem. So: let’s take a look at what we can do.

I am not an engineer or a physicist. Neither do I have any (decent) technical knowledge. Nevertheless, it seems fair to say that the storage of electrical energy in batteries is difficult, to say the least, to implement on a global scale. So we must look for other ways to store (electrical) energy. Because that’s what we need: storing energy is required as long as we cannot exactly match supply and demand. And that’s the way it is: people aren’t going to watch television at night simply because there is an oversupply of electrical energy at that point in time. No, people want their needs met right now. It might be possible to mold people’s desires into a form that better matches the (electrical) energy supply at a particular point in time; for example, by charging the use of electricity on peak hours. However, this, like tax on smoking, seems to hurt us in our self-determination: we want to decide what to do and when to do it, not the government or any other party.

So what options are left? Dams? Sure: that could be possible. We could use excess electrical energy to pump up water, so that we can use this potential energy at a later point in time (at peak hours, for example). But that’s expensive, right? Building dams? So what about this bold conjecture: since the water level is getting higher and higher, why can’t we use the rising water level as a potential energy source? I understand that using the rising water level is not going to lower the water level: the water comes, one way or another, always back in the oceans. It’s not like we can deplete the oceans by using its water. However, that is not to say that there might not be a win-win situation available: what if we could mitigate the rise of the water level and at the same time create (potential) electrical energy?

Again: I am not an engineer, but the following plan seems pretty cool to me: what if we could use holes in the ground, like the giant holes created by depleting coal mines, in order to create waterfall like structures that drive generators. Then we could come up with electrical energy, right? Furthermore, we would mitigate the rise of the water level. Think about it: why do we have to build dams up high? Why can’t we use the depths of nature, the natural spaces in the ground, in order to let gravity do what it does best, and supply us with energy?

Another, possibly far-fetched, idea is a smaller one: it is about freighters (ships) crossing the oceans. Why do these ships always have to run on fuel? They don’t seem to be in that much of a hurry, right? Can’t we just use the power of the wind to blow them forth? Or solar energy, for that matter.

I don’t know how to save the planet, but I do know one thing: we should let our imagination do the work: be wild and think about it. When the point is reached at which the economic benefits of renewable energy are more profitable than fossil fuels, the paradigm shift will be made: we will all go green. And the great thing about this paradigm shift is: you can see it coming.

But what do you think?