The actions of the irrational investor are such that they pile on in the market when they feel there is a positive situation and this is not a good thing as it will reduce the returns for whoever is selling, and on the other hand where there is an adverse situation with a negative message then they might end up selling it and this will also result in issues for other investors and stakeholders (Goldstein et al, 2004).
For instance, “Let’s take, as an example, XYZ Inc., and say it’s trading at $100, with 100 investors following it. The 80 rational investors have decided $100 is the fair value of the company based on future business prospects. The other 20 buy and sell based on irrelevant information. As XYZ’s revenues increase, rational investors bid the stock up to $120—buyers are willing to pay the higher price based on improved business prospects. Now the 20 irrational investors, all momentum players, begin to buy the stock due to its performance, driving the stock up to $135. They buy from rational people who are willing to sell their stock above their perceived fair value. Ten of the rational investors, who either believe they’re misinterpreting the information or who feeling pain because they are not long in XYZ, become irrational and also buy the stock, driving it up to $145. This process can spiral out of control and create a positive feedback loop, causing unbelievable valuations. All this started with 20 irrational investors and a small amount of positive news in XYZ Inc” (Kestner, 2003, p.23).
So where there are irrational investors then there is a cluster effect resulting in an easier market crash, as the history in late 1990s and the early part of the 2000s seem to suggest. The use of rational methods is hence surer compared to that of the use of others. On the other hand, there are also cons found in the Quantitative Trading strategy. As the Quantitative Trading strategy is seen to be one that is heavily invested in the notion that human emotions and thought processes could be basically flawed when it comes to investment technicalities, it can also be argued that the human form of evaluation would actually be more comprehensive compared to that of other processes (Fifield, t al, 2005).
In the human evaluation processes it is often identified that there is a more holistic outlook which the Quantitative Trading might not possess. Quantitative Trading might end up overlooking some of the basic fundamentals that come with the evaluation such as that of things that might not have a monetary value associated with it but could be just as valuable. For instance, value associations can be understood from the context of quality of management of the company, or the working culture of the company etc (Wilmott, 2013). These can be called the less tangible aspects when it comes to evaluation, the less tangible aspects play as much a role in trading and Quantitative Trading models would not always be able to identify these. Only some Quantitative Trading models are so comprehensive in that they are able to make use of these variables and most others only have comprehension based on the financial elements (Szakmary, Shen, and Sharma, 2010).
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