Mad Money
Human aren’t rational especially when money is concerned.
This is typified by CNBC program, aptly named as "Mad Money". The show's host, Jim Cramer is a former hedge fund manager giving his buy/sell recommendation on a number of featured stocks, including stocks suggested by viewers' phone calls or emails. This are often decried as investment pornography or entertainment masquerading as advice similar to advertisements promoting the hot fund. This entertaining show about financial matters has become very popular nature attracted more than hundreds of thousands of viewers nightly. In a study, researchers had gathered stock returns, daily volume data, intraday quotes and other kinds of financial information on buy recommendations that Cramer made between July 28 and October 14, 2005.
KEY FINDINGS:
1. A statistically Significant Short-Term Rise in the price on the day directly following the day it is recommended. This is most apparent for small stocks, where the increase is just over 5% compared to the previous close. For the entire sample, the average rise is almost 2%. These rises were not attributed to any new information. However, the rises were not sustained and faded away within 12 days in what it termed as the "Cramer bounce".
2. Trading volume on these stocks also spiked dramatically. For smaller stocks, the trading volume increased by as much as 900% on the day following the recommendation. In some cases, the level of turnover stayed significantly elevated for as long as 16 days after the recommendation was made.
3. These stocks generally receive much higher buyer-initiated trades on the day following his buy recommendation. This peak in the proportion of buyer-initiated trades ultimately drops back to pre-recommendation levels after about 12 days.
4. It was also determined that the bid-ask spread for recommended stocks did not change at any point in time. A lack of change in the bid ask spread suggests that there is no information asymmetry as a result of Cramer's recommendations. This is because nothing new about the stock has surfaced during that time and, therefore, the current bid-ask spread should still reflect the stocks' fundamentals following Cramer's recommendation, even if the market value of the stock does not.
5. Short sales tended to spike dramatically within the opening minutes of the trading day following Cramer's recommendation. There are at least some rational investors who are aware of the Cramer bounce and are attempting to profit from irrational behaviour.
CONCLUSION OF THE STUDY:
1. This study provides evidence that the irrational behaviours of individual participants in the financial world can create predictable, collective actions that can have at least a short-term influence on stock prices. For the most part, it can be assumed that the investors that are contributing to the Cramer bounce phenomenon are making stock purchases as a result of Jim Cramer's influence, rather than as a product of rational thought. Cramer's recommendations have a direct effect on stocks' prices.
2. This study also shows that stocks are (eventually) driven by fundamentals. The stocks recommended did eventually return to their "true" values. In this case the stocks returned to their original values in a short time span. However, such bubbles sort can also continue for years, as was the case with the dotcom bubble of the late '90s.
3. This study is an example of how irrational behaviour can cause stock prices to fluctuate in a manner that is contrary to efficient market theory. Investors should not discount the role that emotion and investor psychology play in the way the market behaves. While there is no formula or indicator that can account for or assess the emotional aspects of investing, investors can save themselves from being caught up in "madness" by investing prudently, rather than just following the crowd.
Adapted from:
Albert Phung, Mad Money ... Mad Market?, Updated 28 September 2006
http://www.investopedia.com/articles/06/madmoney.asp
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