The stock market werewolves

Hurray! My write-up about the role of moon gravity on stock markets was published by Jakarta Post. I am very happy for it. This moon effect is one of the variables in my PhD thesis. Indeed, I have done extensive literature review to examine whether there is the effect or not.

My suggestion to understand the role of moon gravity on stock markets is: (1) Read the Prospect Theory, (2) Understand the Forgas’ Affect Infusion Model, (3) Read the pros-cons of the role of full moon in psychology literature (I mentioned it in my opinion in Jakarta Post).

Here is my write-up that published by jakarta post. Hopefully, you can enjoy it. You can see it directly from this link:

http://www.thejakartapost.com/news/2012/09/06/the-stock-market-werewolves-full-moon-transforms-investment.html

The stock market werewolves: Full moon transforms investment

Rayenda Khresna Brahmana, Penang, Malaysia | Opinion | Thu, September 06 2012, 10:03 AM| JAKARTA POST

Paper Edition | Page: 6

Unlike Jacob Black in the movie Twilight, Lawrence Talbot (played by Benicio del Toro) and John Talbot (Anthony Hopkins) have to wait for a full moon to transform into werewolves in The Wolfman (2010); a version of the ancient legend of humans that change into a wolfmonster at the full moon.

Indeed, the role of the full moon on human behavior has been described in many civilizations (from Sumeria to ancient China, and not least in our Moon-based calendar). The word “lunatic” itself comes from the word lunaticus which means moonstruck.

Can you imagine if there was a pack of werewolves in the stock market, what would the market be like? Would the investing style be more lunatic with lycans? Could we “herd” the werewolves to beat the market?

These are the important questions for practitioners.

Actually, the effect of the full moon has already been well documented in psychological literature. For instance, Human Aggression and the Lunar Synodic Phase by Arnold Lieber showed the relationship between aggressiveness and the full moon; Lunacy revisited: The influence of the moon on mental health and quality of life by William Barr documented the role of the full moon on mental health and Madness and Moon: The Lunar Cycle and Psychopathology by Mark Owens and Ian McGowan addressed the full moon phase as the source of madness.

In a nutshell, there is indeed a relationship between the full moon and human behavior. It is not a weird idea.

In financial literature, it has been proved that returns at the full moon are smaller than during a new moon. Ilia Dichev, a professor at University of Michigan, in collaboration with Troy Janes, a professor at New York State University, found returns between the full moon and a new moon phase were 10
percent lower.

My co-authors (Hooy Chee Wooi and Zamri Ahmad) and I presented a similar conclusion during the Malaysia Finance Association conference recently. We discovered that at the full moon, seven stock markets (ASEAN-4, Japan, the UK and the US) tended to see more aggressive selling.

If there is a pack of werewolves in the stock market, what should the other investors do?

There are several investing strategies worth trying.

First is the seasonality strategy. Based on the findings of Prof Dichev and Prof. Janes, from the first quarter to the full moon, returns are historically negative by up to 0.03 percent.

From full moon to the last quarter they are positive 0.02 percent. This strategy is similar to turn-of-the month investing. Investors can check the moon phases, and fit their strategies accordingly.

Based on our findings in the Indonesia Capital Market Review Journal, the full moon led to negative returns of 0.03 percent but new moons saw positive returns of 0.087 percent in the Indonesian stock market. In short, if there are werewolves in the stock market, seasonal trading is one of the best strategies.

Second, based on Lu Zheng (University of California), Kathy Yuan (University of Michigan), and Qiaoqiao Zhu (University of Michigan), another opportunistic strategy is called small caps strategy.

The aggressive investor during the full moon usually trades on small caps. As the full moon effect appears strongest in small caps, other investors can trade those small capitalization stocks during the full moon.

Would a trading strategy work to exploit the werewolf in the stock market? Possibly. How far can it yield good returns? There are three big caveats in this matter.

First, if the transaction costs can be minimized the strategy can work but if every month you have to sell and buy, the transaction costs can constrain profits.

Second, there is no guarantee that seasonality will always occur. It is just like a momentum strategy. Based on literature, seasonality in Asian markets is only short term (three months) or long term (48 to 60 months).

There is also market gossip stating that the possibility of profits through seasonality trading is only 60 percent. Even though it has not been well proven academically, it is very hard to find investors who want to gamble their hard-earned money on those odds.

Lastly, most of the werewolves in the stock market are individual investors rather than institutional investors.

Institutional investors, unlike individual investors, typically have a bulky decision-making process, often involving many analysts and fund managers who protect them from the bite of the full moon. Ensuring the stock market in which you are trading is not institutional-investor dominated is more homework for you.

Note also that the concept of werewolves in the stock market contradicts the basic tenet of traditional finance, which is the assumption of rational behavior.

Most traditional financial theories such as the Capital Asset Pricing Model, Portfolio theory and valuation theory, presume the investor is rational when taking decisions.

However, the existence of werewolves in the stock market demolishes those traditional theories to imply more hedonistic behavior. There must be a way to include the lunatic behavior of investors in the decision model.

Furthermore, if those theories are no longer valid, how can the practitioners employ their theories in the real world? A pertinent issue for the future.

In time, it is possible that equity analyst reports will mention the moon cycle in their daily reports. You already understand; having werewolves in the stock market is not scary at all.

In fact, you can profit from their behavior as long as you are patient enough to wait for the full moon, and catch the right momentum when you start to hear the howling.

The writer works as a research fellow at the School of Management, Universiti Sains Malaysia. The opinions expressed are his own.

THANK YOU JAKARTA POST!

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