Original subtitles

The Real Context of the Markets This first module begins by putting into

the current market situation.

This information is of vital importance.

It forms part of the foundations of the most theoretical aspect of the knowledge

we need and on which we build all subsequent training resources.

The markets have undergone a paradigm shift.

In just a few years, as a result of technological advances, Trading in them

gone from being carried out entirely in person to being carried out totally

electronically.

This has contributed to the emergence of new players in the world of investing,

new ways of trading, and even new markets.

All this has undeniably led to the democratization of investing, allowing

to retail traders who, up to only a few years ago, were prohibited from

participating.

In this regard, It is no coincidence that most retail traders end up with

losses. The entire industry is set up for this to be the case and for

participation to simply serve as yet another very small source of liquidity

the market.

It is important that you keep your feet on the ground.

The world of trading and investing is too complex for a home -based retail

trader with an internet connection and a computer to obtain any major returns on

their capital.

Everything is stacked against them, starting with the fact that this is an

dominated by large institutions, which dedicate huge amounts of money both to

the development of powerful tools and to hiring the most skilled people.

I will now take a very basic look at some of the lesser known aspects of the

current trading ecosystem, which may be of some relevance as they can influence

our trading approach.

Financial Theories

Economists have always had a special interest in describing the behavior of

financial markets in the most realistic way possible, which has led to a series

of theories being postulated for this purpose.

Based on the rationality or irrationality of the agents, all the

aimed at defending the efficiency or inefficiency of the market with respect

information with the ability to influence the asset price, that which

exists and that which will be generated.

The first major accepted theory was the efficient market hypothesis, after which

a new way of thinking emerged, the theory of behavioral finance.

More recently, a new approach has been postulated, the adaptive market

hypothesis. I will try to explain the most important points of each of them

below. The efficient market hypothesis, EMH, markets reflect all available

information quickly and accurately.

The efficient markets hypothesis is a financial theory that argues that

financial markets are efficient and reflect all available information

and accurately.

This means that fundamental and technical analysis are not useful tools

taking profits over and above random performance.

However, some irrational behavior in the markets, such as bubbles, cast doubt on

the validity of this theory.

Behavioral Finance, BF Theory Psychology Affects the Behavior of Agents in

Financial Markets Behavioral finance theory focuses on the study of how

psychology affects the behavior of agents in financial markets and how the

behavioral biases and cognitive limitations of participants can lead to

rational behavior that generates inefficiencies in price formation.

The Adaptive Market Hypothesis AMH Market conditions are ever -changing.

and rationality and irrationality coexist.

Finally, the adaptive markets hypothesis is an approach that tries to reconcile

insights from the efficient market hypothesis with behavioral finance and

psychology, and is based on the evolution and adaptability of market

Let's look in a bit more detail at the adaptive markets hypothesis, since it is

the fundamental theoretical basis on which all the studies of the course are

based.

Presented by economist Andrew Lowe in 2004, this theory adopts a more holistic

view of markets by trying to reconcile insights from the efficient market

hypothesis with behavioral finance and psychology.

It does not assume that the previous two theories are wrong, but that they are

incomplete.

In the author's words, behavioral anomalies and efficient markets are

sides of the same coin. They reflect the dual nature of human behavior.

The fact is that sometimes we're rational and sometimes we're emotional.

Usually, we're a bit of both.

This theory is based on the evolution and adaptability of agents.

It implies that behaviors are constructed and shaped by the continuous

interaction of the agent's own internal reasoning, together with the external

conditions of the current environment.

This new approach is situated somewhere between the two previous theories.

The agent is not assumed to be rational or irrational.

Depending on market conditions, agents will act in one way or another.

In a stable environment, agents will act more rationally, while in an unstable,

volatile environment with excessive uncertainty, different behavioral biases

will be activated, leading them to act more irrationally in order to overcome

the challenges they face.

This theory does not assume that the market is either efficient or

Rather, it depends on the moment due to the flow of information and the

importance of a changing environment.

The theory is mainly supported by two points.

One, the efficiency of the market depends on its conditions.

The volatile characteristic is the result of the interactions of the

participants, which in turn depend on the market conditions.

Two, the agent is not fully rational and is subject to cognitive biases.

A purely rational model cannot be applied since the participants form

expectations based on different factors.

Moreover, different expectations can be created based on the same information,

not to mention the fact that each agent is risk -averse to a different degree.

We are not all the same, nor do we react in the same way.

Moreover, the same person may react differently to the same event depending

the situation.

It is also worth emphasizing that each person behaves differently depending on

their risk appetite, and the degree of this will also be influenced to a great

extent by the context of the market at the time.

The particular conditions of the market and our own situation as traders all

come into play here.

Both evolve over time.

Although the author refers to agents as individuals, this is equally applicable

to today's trading ecosystem.

Regardless of the market participant and the way in which they interact with the

rest of the market, they will make their decisions based on their assessments,

motives, or needs at any given moment.

And that particular moment will be conditioned by different factors,

that will change over time and therefore lead to change in the assessments,

motives, or needs of the participants.

This hypothesis places more importance on changing market conditions due to the

emergence of new information.

and how participants might react to these.

It focuses on the fact that rationality and irrationality, efficiency and

inefficiency, can coexist in the market at the same time depending on the

conditions.