Blog - Investing Notes

February 16, 2006 – An Overview of Investor Animal Spirits

What formal studies does academia have to offer on the role of emotions in equity investing/trading? In their October 2004 paper entitled "The Role of Feelings in Investor Decision-Making", Michael Dowling and Brian Lucey synthesize the results of two threads of recent areas of research on whether and how emotions affect investing: (1) mood misattribution (the impact of environmental factors, such as the weather, the body's biorhythms and social factors); and (2) image (how investors feel about companies separately from any financial analysis). They note that:

• Traders have heightened emotions around certain events such as increased price volatility.
• There is some theoretical support for feelings influencing equity prices. Even if only a small group of investors are influenced by their mood states, it may still result in identifiable patterns in equity returns.
• Evidence for a "weather effect" on equity prices is mixed. Very cloudy weather may depress stock returns. Cold weather may be better for stocks than hot weather. The moods of market makers (rather than those of investors/traders) may be key to the influence of weather on stock prices.
• Seasonal variation in the amount of sunlight may affect stock returns, with decreasing hours of sunlight bearish and increasing hours of sunlight bullish.
• The shift to and from daylight savings time may interrupt sleep patterns, elevating anxiety levels and briefly depressing stock returns.
• Stock returns are better around new moons than full moons, presumably because of a real or perceived lunar influence on biorhythms.
• The outcomes of major sports events may effect stock returns through their effects on national mood.
• Having a vaguely good (bad) image of a company or industry correlates positively with high (low) expectations for the performance of an investment in same, and these skewed expectations may affect stock prices. (Reference the impact on stock prices of companies changing their names to be more "dotcom-like" in the late 1990s.)

In summary, formal research on the emotions of investing suggests that mood affects investor behavior, but it does not offer much in the way of practical trading edges. Keeping one's own emotions in check does seem key to outperforming as a trader.

For related research, see the links at the bottom of our Trading Calendar for items on seasonal and event-related anomalies and our blog entries of:

9/28/05 on overcoming behavioral bias through sophistication (knowledge) and experience;

9/2/05 regarding emotional attraction to/repulsion from previously owned stocks;

4/16/05 concluding that day traders need to control their emotions to perform well;

3/28/05 for a recent overview of behavioral finance research;

2/8/05 finding that new moons are (slightly) good for stocks; and,

12/29/04 on the role of the media in feeding investor/trader emotions.