IRRATIONAL MINDS

Trading Psychology & Behavioural Finance Blog

One of my favourite speculative resource stocks on the ASX, Cockatoo Coal (ASK:COK), exhibited some erratic behaviour this week - From a low of 68 cents on 2nd January, it reached a high of $1.135 on 7th January. I’m of the opinion that this event was the result of informed trading. Informed trading, insider trading, illegal trading, feel free to use whatever definition you like. I like the term informed because it covers value traders, news traders, information-oriented trades and arbitraguers, but more on that later. For now, what COK exhibits is the unmistakable earmarks of insider trading - ie “individuals who have access to nonpublic information”.

But what I like best is not so much the characteristics of insider trading you can see in the market on any day eg. increased volume on an upward price movement with no news (coal prices have been ramped up but not to the extent of this price breakout), and the price spike a day before an announcement. Rather its the way that the information is aggregated to the market, and the resulting bubble that the insiders most likely would have sold into.

The day after the big white candle (January 8th) a fairly mediocre announcement was released regarding the aquisition of further exploration tenements. Certainly not a bad announcement, but not the sort of climax one would expect after a >60% rise in the pre-announcement stock price. In the ensuing hours and days, as clearly expected, the stock has been sold off. As I write this post COK is trading at 85 cents.

Plott et al have carried out experiments to demonstrate the arrival of information from informed traders in the stockmarket, and the aggregation of this information to the market (Plott et al, 2004). Or in laymans terms, what effect insider traders have on the price of a stock. They use the pricing structure of an option with an underlying asset. A handful of ‘insiders’ are given knowledge as to where the price of the underlying asset will be at the end of the ‘trading session’. Interestingly, the experimental market shows that information held by a few is aggregated throughout the market. This process follows a path: The first to arrive in a market in time and in terms of commitment are those with the information. The informed traders place limit orders early in the period and the uninformed traders place market orders that cross with the informed traders.

I know its hardly bedtime reading for some, but this paper really is an interesting read and I like how it proves with clarity what is clearly happening in the market every day. The informed buy early and push the price up. The uninformed follow, pushing the price up to mostly irrational levels. The informed then sell to the uninformed (post announcement or just before), and the cycle is complete.

Of course there are other factors that have influenced the price of this stock pre-announcement. Writeups of the stocks attractive outlook have been in The Australian paper, as well as a buy recommendation by a broker. In my opinion all this did was serve to increase the gusto of the uninformed to buy at extremely inflated prices. I can only imagine their fear of missing out when at one stage the order book showed only a single seller on the ask side!

*** EDIT *** I just found this related news article that points to the fact that “Cockatoo Coal ‘can’t explain’ share price jump”…