Book Summary: Behavioral Trading by Woody Dorsey

In this summary, you will learn

  • Why investing is not rational;

  • The mind, mood and body theory of behavioral trading; and

  • The investing methodology it suggests.


  • Behavioral economics has always been part of finance, though it has not been widely acknowledged.

  • The idea that people behave rationally when they invest is irrational.

  • Rational economics cannot explain sudden booms or bursting bubbles.

  • Psychological and behavioral factors matter greatly in the market, which has its own mind (emotions), mood (concepts) and body (prices).

  • Mind, mood and body work together and feed each other.

  • People follow contagious information patterns called memes that invade their minds and change their behaviors.

  • Memes are one reason that investors repeat themselves disastrously and never seem to learn from their mistakes.

  • Published information is disinformation.

  • Read the paper to see what people think; ride trends but be ready to bet against them.

  • People who invest based on behavior finance may find charted trends useful

Triunity Theory

“The perpetual dialectic activity between the three brains and the three market functions, Mood, Mind and Body, are what we call Triunity Theory.”

  • Successful traders and investors have always known that there is more to trading and investing than the numbers indicate. People don’t behave rationally. There is nothing rational about greed, fear, lust and other powerful, proven motivations for human conduct.

  • Since markets consist of human beings thinking, feeling and acting, it’s reasonable to apply a more or less Triunitarian principle to the markets.

The Triunity Theory of the market looks at the market analogously:

  • Mood – The emotional factors in the market: optimism, pessimism, fear and so on.

  • Mind – The conceptual conditions of the market, expressed by market fundamentals.

  • Body – The prices in the market, expressed by technical market factors.

“In listening to Soros, Greenspan and Rubin, what we hear is ’experience’ rather than theory.”

  • Frequently, the mind can lead both the mood and the body, as when some overriding investment theme or theory leads investors to bid up prices. Mind, mood and body work together and feed each other

“The stock market is illogical.”

  • Rational economic analysis cannot account for this type of trading pattern. It cannot justify or explain why prices rise to historic heights one day and plunge to historic lows the next, with no apparent change in economic conditions or circumstances.

  • Bubbles and crashes are equally inscrutable to the economic rationalist. According to rational economic analysis, markets are efficient and rapidly incorporate new information into prices; therefore, prices only change as a result of new information flowing into the market. However, analysts are at a loss to explain what new information might have accounted for the Crash of 1929, the Crash of 1987, the Dot-com Bubble or its aftermath.

  • That is why behavioral analysis is supplanting old-fashioned rational analysis, and why no one accepts a pure efficient market theory anymore. Such economic leaders as speculator/philosopher George Soros, Greenspan and former treasury secretary Robert Rubin have all spoken of the importance of emotional and psychological factors in the market, not just classic economic ones.


  • What is the Mind of the market? What does the market think? How do you find out?

  • The essence of the market’s mind is the Transient Investment Themes. Transient Investment Themes are explanations offered for the market’s conduct. When people repeat an explanation often enough, they may begin to believe it, and a theme then becomes an obsession. The theme doesn’t have to be true to be effective; it merely needs to be believed.

  • Whatever the theme, people tend to react the same way, over and over. The market is a story, or a drama that follows the same pattern repeatedly.


  • How do you know when the market is feeling moody? One way is to follow the media. Not follow it in the sense of believe it, but rather follow it in the sense of watch it closely and then act astutely contrary. The newspaper does not provide information; instead, it provides disinformation. A newspaper shapes the thinking of its audience.


  • Price is the body of the market. You can see a lot in the chart of prices, but people often miss what they see. Not the discovery of ancient, frozen cadavers, although an argument might be made for that, but people ignoring the obvious and searching for a subtle unknown.

  • Efficient markets theorists believe that stock price moves are random reactions to new information and not the consequence of a repeating drama of mood and mind. They, therefore, believe that charts of stock prices contain no useful information, or very little.

  • In fact, though, some very astute and successful investors rely on charts. Used with discipline, the chart of stock price moves can be a very useful tool. Of course, it is important to avoid the distraction and be aware of optical and cognitive illusions. That said, market price moves do repeat themselves. It’s clear for example that a market bottom may precede a "secondary low" almost but not quite as low as the bottom. The secondary low, in turn, precedes a rally. It happens over and over again.

Remember these principles about technical analysis and price moves:

  • People learn to see and see what they have learned (and been taught) to notice.

  • Always examine what you see and why you see it.

  • There are patterns in market price moves.

  • Good traders who understand behavior trade on the patterns.

  • Everything repeats: emotions, investment themes and price moves.

  • Investors make the same errors repeatedly and the astute trader profits


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© 2016 by aTrader