Trading on Sentiment – The Power of Minds Over Markets : [PDF Download]

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“Keynes used an allegory to demonstrate how the collective behavior of investors moves stock prices. In the 1930s, newspaper beauty contests were occasionally held. In these contests, one hundred photographs of faces were displayed in the newspaper.

Participants were asked to identify the six faces that they believed would be chosen as the prettiest by all players. Those who guessed the consensus six faces won a prize. In this contest, one’s own opinion of attractiveness was not as important as the collective preference.

The key to selecting the winner lay in anticipating the faces others would select. There are several ways to approach this game. The simplest strategy is to select the six prettiest faces in one’s own opinion, without considering the preferences of others.

According to game theory models, such a strategy is a Level 0 strategy. A more sophisticated player ought to understand and consider others’ perceptions of beauty. Using that information, this strategy should be more likely to succeed—a Level 1 strategy according to game theory.”

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