Behavior Trading

Woody Dorsey

Behavioral Trading is a book whose cover says it provides "Methods for Measuring Investor Behavior, Confidence, Expectations and Market Trends". To some degree it does deliver on this promise. While it does provide a prescient analysis of the trends that contributed to the stock market bubble of 2000 and the many false bottoms after that, we'll never know how good it is until the next market bubble and collapse.

Since the time period between these massive market movements can be measured in decades, there is some doubt about the usefulness of this analysis. The book does provide good psychological justification for why people put money into a market that is overvalued by any traditional measure.

It accurately shows how people talk themselves into buying stocks that they would not normally buy. Though I wasn't wiped out in the bear market, the words the author used were familiar. They were once heard in my own head.

One of the most important quotes in the book regards our attitude toward loss:

"Losing $100 is not offset by gaining $100. Losing hurts a lot. In some ways, we have been taught that losers suck. Furthermore, we are sort of expected to be winners. At least everyone wants to be a winner." This can effect our attitude toward risk and our rationality and prevent us from making rational decisions in the future.

The book has several charts showing the stages the market went through from the bubble, dubbed e-greed through final capitulation in August of 2002. The graph makes sense from the aspect of historical analysis.

My analysis of Mister Dorsey's graph runs as follows: First, the overall market lows in 2002 were significantly lower than the lows in the weeks after the 9-11 shock. The author implies that the market was headed toward its 2002 lows and was going to get there regardless of the terrorist attacks in 2001.

This is simply not true. The September 11 attacks did hundreds of billions of dollars of physical and economic damage. It pushed the Federal government from surplus to deficit. It crushed consumer confidence and cost perhaps a million jobs. This affected corporate profits, expectation for corporate profits and therefore market valuation.

I cannot predict what the market would have done absent the September 11 shock. To imply the 2002 lows were inevitable is not an argument supported by the facts.

The book suffers from references to Dorsey's other works, which leave the reader needing to purchase the other book to understand this one. That may be good marketing, but its not good writing.

This book is a difficult but necessary read for anyone that took heavy losses when the bubble burst from 2000-2002. It is valuable in spotting bad trends in thinking and investment. I think in spite of some shortcomings its worth the price.