I used to work for financial traders. I even used to have a brightly colored coat and a trading floor badge, back when that mattered. I've read The Economist for 20 years. Despite understanding the financial markets better than most, I never trade individual stocks. Everything's in low-load funds; I look at the allocations every year or two.
Why? Because I know what I'm up against. I have friends who are still in the industry, deploying vast computational and financial resources to make money. For any given stock, there are people who follow the company and its markets more closely than I ever will. And all of those people regularly fuck up, losing millions. I'm not interested in stepping to that.
And there's another big reason: it's a giant minefield of cognitive biases and emotional weirdness. For example, you can think of the market as a random walk with an upward bias. Year on year, you're generally up. But day by day, you're can be down nearly as often as up. Because of loss aversion , you'll feel the losses more strongly than the gains. Looking at your stocks every day will at least add to your stress levels, and maybe your decisions will get thrown off. (This example is taken from the excellent Fooled by Randomness , which I recommend to anybody who wants to trade, or even understand the financial markets.)
I focus my energies on areas where I have a an actual advantage, and I encourage others to do the same.
This suggests a possible scam (probably not an original suggestion). Set up some large-enough number, maybe 30 or 40, shell investment companies. Each one trades according to a very specific but randomly generated strategy, which it publicly announces in advance. (Some care would have to be taken in generating the strategies, but they should be such that they're expected to match the market, when taken as an ensemble.)
After a few years, some of these strategies will have turned out to be successful, others haven't. Quietly wind down the unsuccessful ones. The successful ones now look prescient: this firm announced in, say, 2008, that the market conditions were such that strategy X is clearly correct going forward. And history has now borne them out: here, five years later, their prediction was right and their portfolio is up 1000%. Of course, there is missing information, that this was just one of 40 shell companies, and overall returns across all companies did not beat the market. But now this successful company can sell investment services/consulting/whatever on the basis of its individual track record.
I suspect actual investment consultants are effectively doing a distributed, non-coordinated version of this, even if not intentionally.
A recent grad looking for a job with an investment bank picked 64 banks and sent each of them a letter introducing himself. To a half of them he also added that next week Ford stock will be up and to other half he said it would be down.
Next week, one half of the banks were off the list, because he was wrong. He split remaining banks in half again, sent another letter making his up/down prediction and repeated again for 4 more weeks. After 6 week there was just one bank on the list, but it was the one that saw him make an accurate prediction 6 times in a row. And so he sent them the job application.
My bank advised me to invest in "Investment Fund #17": their headline info was that this fund marginally beat market average in each of the last 3 years.
I decided to invest elsewhere.
But here's what I don't get. It seems like such a reliable and lucrative scam that there should be dozens of managed funds who have grown by 1000% over the last 10 years. Where are they all?
One of my favorite articles on the persistent mistaking of luck for skill in the investment management industry is "Track Records are Rubbish (or Why Managers are Factors in Drag)" . A short excerpt:
...most managers are really just overconfident, incoherent collections of habits, assumptions, ideologies, and cognitive and emotional biases emanating from the most dangerous black-box of all - the human mind.
Sometimes these habits, assumptions and biases are aligned with the market, and the manager does well. Sometimes the manager is 'out of sync', and he does poorly.
This quote neatly summarizes what I fundamentally don't accept about this viewpoint. Specifically, most of the article's arguments are those you encounter from Efficient Market Theory which has pervaded our financial education to the point of being accepted as blindly as faith and has lead to a lot of pain & suffering by investors. Here are some key messages from the article which I find incredibly dangerous and damaging:
1) UNLESS YOU ARE "SPECIAL", INVEST IN INDEX FUNDS
Index investing has become a sexy mantra in the era of EMH and passive investing. If you can't beat the market - why not just follow it? At first glance it does seem like a great option as it cuts out middlemen fund managers who seem to invest on chance. However, it's a mantra that is self defeating as more investors adopt it. Although indexing is predicated on efficient markets, the higher the percentage of all investors who index, the more inefficient the markets become as fewer and fewer investors would be performing research and fundamental analysis of equities. At the very extreme, if everyone practiced index investing, stock prices would actually never change relative to each other since everyone would be "all in" [I've loosely paraphrased Seth Klarman's arguments from Margin of Safety but for a much more exhaustive treatise please dive into the novel]
I think a golden rule of investing is you should reject any absolute assessment of a investment vehicles ("gold always goes up", "invest in index funds", "junk bond funds have lower risk at higher return"). Wall Street loves to peddle their latest, shiny investment creations; don't rely on their faith - no matter what you invest in, you better do some damn research on it (even an index fund).
2) STOCK PRICES REFLECT THE CONSENSUS AND GOING AGAINST THE CONSENSUS IS BAD (worded as aggressive in the article)
This is in it's heart is the essence of the efficient market hypothesis - prices are rational and reflect underlying public information. I'm not going to into a huge essay against pricing being rational but history has shown time and again that prices reach irrational exuberance; tulip mania and trading sardines are not merely historical phenomenon. Intelligent Investor by Ben Graham details out some clear cases where stock prices did not reflect anything remotely close to underlying public information. Off the top of my head, there are many examples where passively managed closed end mutual funds traded significantly from their NAV value (which makes little sense). Historical records shows that supply and demand factors (rather than underlying information and rational actors) drive stock market prices.
As a nice hypothetical example, let's think of a change in the S&P 500 where the new stock AWSM pushed out OLDFTHFUL from the S&P 500. Let's assume the changing of the index happened during a lull period in both companies where no material information about the companies was given out (i.e. their economic forecasts were stable during the S&P shuffling). Since everyone was following the "invest in index funds" argument of the author, this triggers billions of purchase orders for AWSM and lots of sell orders for OLDFTHFUL. Naturally one stock rises while the other stock falls even though there has been absolutely no change in the forecast for either company.
3) YOU ARE COMPLETELY BEHIND THE CURVE WHEN INVESTING - DON'T BOTHER UNLESS YOU KNOW INSIDE INFORMATION
Nothing could be the further from the truth. Frankly, it's probably one of the best times to do rigorous stock analysis since 1) we are in a time when most investors embrace the EMT and thus don't bother doing even basic fundamental analysis 2) financial info and SEC filings can be easily acquired through the internet & hacking and financial modeling can be easily done with Excel & programming 3) many of the institutional actors that drive the market are not incentivized to conduct fundamental analysis. Specifically, mutual funds have specific characteristics that prevent them from acting rationally (requirements on diversification, inability to short equities, large fund size, low cash reserves, etc.). Hedge funds have similar issues (20% fee structures which incentivize short term thinking).
Things might not be as rosy as during Ben Graham's time, but don't fool yourself into thinking that doing research into your investments is a waste of time. Any natural scientist will never accept that further research will yield nothing, but for some reason we accept this in the investing world.
4) YOU ARE TRADING AGAINST GOLDMAN SACHS. DO YOU REALLY WANT TO BET AGAINST GOLDMAN?
I hate this perception; Wall Street's business model is largely driven by volume rather than investment acumen. I.e. they make money as long as the market moves, regardless of the direction. Goldman is a giant because they manage the machinery of markets, not because they are expert stock pickers.
Overall, I think the world would do a lot better with this advice: "A stock is a small percentage share of a company. Treat investing your money in an equity exactly as you would treat investing in a business." I think most of the investing mistakes alluded to this article would be prevented by heeding this advice.
Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees. Those following this path are sure to beat the net results (after fees and expense) delivered by the great majority of investment professionals. Seriously, costs matter.
True, he doesn't say you can't beat the market. But he does say, then and now, that you probably shouldn't bother trying.
Plus, say through in-depth research and know-how, you do manage to beat the market. At best, you've created a part-time job for yourself. Unless you're managing other people's money, or have a 7-figure+ portfolio, I expect the time taken to do the due diligence necessary to consistently beat the market - if indeed such a thing is possible - would end up paying a lower hourly rate than you could earn doing other, more reliable, less zero-sum things.
Of course most people wont suddenly have a 7+ figure portfolio, but will first have a 5+ and then 6+ figure portfolio. Yes I researched something for days when I was only investing $30K and that could be called a low hourly rate job, but I was learning an immense amount and now can do the same research in only a few hours all while dealing with a significantly larger amount so my "hourly rate" keeps going up.
And for what it is worth I am really enjoying the process.
I certainly don't think there's a problem with devoting a small percentage of your portfolio (say 5%) to stock picks, or even a larger percentage split over multiple stocks, if you enjoy doing it. I occasionally do it with 5% too. But with retirement savings, I like to have as many guarantees as possible. By investing globally in index funds, I have as much confidence as possible that unless the world implodes, my savings will grow over the coming decades. If I pick individual stocks, even a decent number of them - holding say 10-15 at a time - and even if I actually AM really good at it, it is entirely feasible that I could lose money in the long term through bad luck alone. So even if I can increase my expected value through stock picking, I also significantly increase my risk.
I find personal finance fascinating too, but I prefer to spend my hobby time studying multifactor investing (regression analysis, etc.) and researching the optimal funds to achieve a moderate small and value tilt, while maintaining low costs and broad diversification.
-Your life or your money (personal finance more than investing)
-The Warren Buffett Way
-The Five Rules for Successful Stock Investing: Morningstar's Guide to Building Wealth and Winning in the Market...
My top book recommendation BTW would be the 4 Pillars of Investing by Bill Bernstein.
The the truth is, you can't be lazy - it's simply not an option. It's the burden of having savings. You need to research your investment decisions and understand your financial goals even if you decide you want a passive investment strategy. Why? Here are a few scenarios where investing the majority of your savings in index funds probably won't make sense:
i) You are approaching retirement age and will be living off your savings in the next few years. You have saved just enough to live out your expected lifetime.
ii) You are a young hacker and will be bootstrapping with your friends in a few years (sounds familiar?). You are close to saving enough to pay for your personal burn & even server costs for a year.
i) & ii) are clear cases where the users need liquidity and are unable to handle index fund volatility.
No one lazy would realize this. The truth is those who decide they don't want to actively manage a portfolio still need to understand a lot of things (savings accounts, CDs, annuities, bonds, treasuries, etc.) before they decide to jump into index funds.
Essentially, I think investing is a part time job regardless of your strategy. It's the burden of having savings.
Hence, it may not be your intention, but you are using Buffet's quote to make the exact opposite point of what Buffet himself originally intended. And he has often spoken on this subject. See also Mohnish Pabrai and his book 'The Dhandho Investor'.
Still, the default advice of the supposed world's greatest stock picker is to stick with index funds. It's not, "Here are my rules of thumb for picking great stocks," or something along those lines. (I strongly suspect that Graham's advice would have been the same if index funds had been an option in his time.) That suggests to me that at the very least, he clearly believes that picking stocks is difficult. So sure, Warren Buffet, someone who you would expect to be highly biased toward stock picking, doesn't completely rule it out. But he doesn't endorse it in general either.
Burton Malkiel (of "Random Walk Down Wall Street" fame) responds :
FORTUNE: What if everyone owned index funds? What would happen to returns then?
MALKIEL: There's a paradox about this. It's actually the professionals' reacting immediately to news that makes the stock market efficient. So it's theoretically possible that if 99% of the market were indexed, indexing would stop working. There'd be no one left to make the market efficient. But only about 10% of money is indexed now. I'd say we could have half of the money in the market indexed, and there would still be plenty of people to make it efficient.
When a trader's prediction is proven correct (assuming it is), they pocket an amount of money proportional to how incorrect the market was when they made their trade and how much of a risk they took (i.e, how much money they traded), thus being rewarded for the value of the new information.
Thus, the market is not efficient, but it asymptotically approaches perfect efficiency as the volume of trades increases. It's never 100% efficient but indexers assume it's close enough and that incentive of discovering the remaining inefficiencies is not worth the cost and risk. These days, that should be the case for most, if not all, individual traders.
If I understand things correctly, an index fund will end up reducing the efficiency of the market. But this is not necessarily a bad thing: it means that, as the portion of invested money that's in indexed funds increases, the value of new information that a non-index trader introduces to the market increases.
This creates a greater incentive for someone to discover and trade based on new information. The tension there will create an equilibrium point at some point below 100% indexed, meaning that the markets will never switch entirely to indexing.
That may be true for an investor, but it is completely false when speaking of a trader. A trader need not know the underlying stock to make a profit consistently. The uninformed continue to think trading and investing are the same. They are nothing alike.
Regardless, let's suppose the mantra is "invest all your money in index funds until it breaks 50% after which bad things may happen". Do you think that if we manage to hit that 50% in the future, anyone will actually actively try to stop people from investing in index funds? Effectively there would be a lot of money very rich index fund managers who will be pushing to increase their fund sizes even further.
So it's possible for extreme irrational exuberance to cause even index funds to harm the market.
I agree that the Efficient Market Hypothesis is a load of rubbish repeatedly disproved by the movements of the markets not to mention the impossibility of the assumptions on which it relies (perfect information etc.). However if you are investing from a position of ignorance or sentiment (rather than on the Intelligent Investor basis) then the EMH may as well be true. It is only worth trading when you believe that you have an advantage from such proper analysis. For most people this is pretty much never - which is where the original poster's advice comes in.
So if you do have valuable industry knowledge and the time to glance at the basic company figures OR time to fully analyse the fundamentals of companies in the Intelligent Investor style go ahead you may well come out ahead but do remember that the market can know something you don't and/or remain irrational so you need fairly long time horizons.
My summary is if you have an advantage use it, if not then use index funds.
In any case, since you are now revealing that the movements of the market disprove the EMH, I take it you've already made your billions by trading your EMH-disproving strategy?
Steve Keen devotes a the second half of chapter 11 in Debunking Economics to the EMH. The core issues are that the empirical data does not support it and that the maths behind it is all based on the assumptions that everyone can borrow freely at the same risk free rate and secondly that everyone has the same expectations ("homogenity of investor expectations: investors are assumed to agree on the prospects of various instruments - the expected values, standard deviations and correlation coefficients..." - Sharpe 1964 quoted in Debunking Economics 2011.)
That the EMH may be false does not mean that I believe I will necessarily win any more than the fact that Poker is significantly a game of skill means that I would necessarily win. I can be outplayed and/or have luck against me. But I wouldn't play for significant money unless I strongly believed that I had the advantage, the same is true for the market.
If the EMH were false, a trading strategy generating above-market (risk-adjusted) returns over the long haul would exist. Claiming such a strategy exists is far more plausible if you've already traded it and won.
Let's say I think the EMH is false, because, I dunno, I think people are irrational and emotional a lot of the time. It doesn't necessarily follow from that that I can beat the market by betting on people being irrational -- irrationality is really hard to predict, people could be irrational in many different directions.
How it implies there is a strategy to beat the market? Simple. Suppose you have knowledge (e.g., the next iPhone causes cancer) that the market has not incorporated. You can use that knowledge to trade since the people not using that information will give you favorable prices (in this case by shorting AAPL).
Ultimately the problem with the EMH is the name. It's a fairly technical result that most people don't understand. People hear "Efficient Markets Hypothesis", they think it means "markets are magic fluffy bunnies that protect puppies from twisted stomachs and cure inequality", and argue against that.
You seem to think that "market is sometimes wrong" somehow implies "you can always beat the market". That's not what we're saying. We are saying the market is clearly wrong often, so there exists some space for speculation arbitrage.
This implies that you made the round trip (ie bought and sold). If not, you've made exactly zero.
So what was it that you saw, that institutional investors missed, that caused you to buy? What changed with the company's prospects in the past year that caused you to sell recently, and book your profit?
Otherwise, you haven't "beaten" anyone.
"So what was it that you saw, that institutional investors missed, that caused you to buy?"
At the time, there was a large distrust in the financial community that Tesla had the production capacity to meet its Q42012 sales goals (I believe it was between 3-5k Model Ss, they ended up selling 6k). It further followed that Tesla failing to meet its sales goals would undermine investor confidence in the company and squeeze TSLA's operating capital in the coming 1-2 year period.
I disagreed with both hypotheses. The funny thing is, my strategy wasn't even smart. I know nothing about Tesla's production capabilities, what the bottlenecks were, or if they were likely to succeed. I assume that information had been priced into the market. Essentially, I bet on Elon Musk. I don't know what the bottlenecks were, I saw the Model S and shit my pants and said "This is awesome" and then I bought options.
I really only have one point to make, which is that if you think TSLA going from $30 to $180 / share in less than a year is a completely random, unguessable market move, well, I don't know what to tell you. It's not to me.
(just kidding, that one is longer)
The EMH is based on the assumption that prices perfectly reflect the available information on the underlying. This is mentioned in the second paragraph of the Wikipedia article you quoted. You can't invoke the EMH as a model of the market and then violate one of its core assumptions when defending it.
A trading strategy generating above-market (risk-adjusted) returns may be a proof of the problems in the EMH but it isn't the only one. Also once declared it may no longer be an effective strategy. It also isn't proof because it is impossible to prove that success over n years proves success over n+1 years.
However how about asking Warren Buffet if the EMH is true, would you accept his track record as proof against the EMH? If not what sort of trading strategy/record would you suggest might constitute the evidence that you are asking for.
Going back to my poker example, do you expect me to win the World Series of Poker to prove that Poker isn't just random luck and chance? Is once enough or do I have to repeat it?
How does a boom and bust prove the EMH false? Could you explain the mechanics in detail?
Going back to your poker example, if top players in poker were rare and gains/losses seemed random, that would be evidence that Poker is mostly just luck.
If you accept that Warren Buffet and a few others are evidence that the EMH is imperfect (rather than the positive examples of long lucky runs - in a large population you would expect some very long lucky runs) then you are acknowledging the EMH is false. The existence of those who can beat the market is proof, the number of them doesn't matter.
Booms and busts are evidence (not proof) against the EMH because efficient accurate prices won't jump suddenly without specific new information about the underlying value of stocks/commodities/derivatives. Given the size of the shifts and that common absence of major news that triggered them I think it is hard to argue that a number of busts are evidence against the EMH. Likewise speculative bubbles that have inflated the value of things to many times their previous value based largely on the expectation of further growth are again evidence (rather than proof) of the flaws in the EMH.
From the perspective of someone considering playing the market the EMH is a pretty good model. However as an overall macro model of the market it is fairly poor and certainly not something that should be treated as true to then develop further theories on top of. For example I do not believe that markets will always produce the best results and price goods correctly but I am generally sceptical of people claiming to be able to beat the market (such people probably exist but it is hard to distinguish them from the lucky).
EMH assumes that the market perfectly translates all information about stocks into prices. In a strong form, that requires perfect information, you can dilute that to almost perfect but just claiming the market is anywhere close rational or efficient is a huge leap given our history of stock markets and bubbles. That claim has been shown to be false in just about every boom bust cycle so far, but to take one specific example - mortgage cdos in the last decade - what about that market was efficient?
I take it you've already made your billions by trading your EMH-disproving strategy?
Disagreeing with the efficient market hypothesis implies nothing about trading or investing competence.
The existence of apparent bubbles does not contradict the EMH. Scott Sumner has a great post explaining this: http://www.themoneyillusion.com/?p=25011
If you believe the boom&bust cycle shows the market to be irrational, what is the EMH-disproving trading strategy? "The market did something I don't like" is not the same thing as "the EMH is false."
I didn't find that link at all convincing, in particular the vague handwaving about bitcoin - because that is as-yet unproven and very uncertain I don't think it's a good example - why not use one of the many stock market busts? Booms and busts are not 'apparent bubbles' in any sense, they are all around us, and cause real movements in the markets regularly. They are a great illustration of markets behaving completely irrationally and becoming divorced from any efficient relationship between price and underlying or future value due to euphoria, panic, over-abstraction or obfuscation of assets and risk, monetary stimulus, corruption, cornering, rumour etc, etc. Sudden resets (often overreactions), and wild swings are the result, so much so that many of our markets have circuit-breakers which stop trading to attempt to discourage their natural movements.
There are a whole host of reasons why our markets are not currently anywhere close to perfect or efficient, and to simply assume they are and then attempt to cut the facts to fit the procrustean bed of market theory is not at all convincing. What is dangerous about the EMH to me is that it encourages a sort of worship of markets, which are seen as efficient and all-knowing, and which can never be gainsaid. In fact markets get things wrong all the time, they are pretty irrational quite a lot of the time, they are just the least-bad system we know.
If you believe the boom & bust cycle shows the market to be irrational, what is the EMH-disproving trading strategy?
Again, not believing the EMH is not the same as believing you can beat the market with short term trading, the two concepts are completely unrelated. I have no idea what sort of trading strategy you think would disprove EMH, but we're not talking about trading strategies but models for markets. Personally, I wouldn't trade short-term at all in stock markets, but do invest. I happen to mostly agree with the author here, but again, that has nothing to do with efficient markets.
The EMH is a postulation which makes extraordinary claims about markets in general, it does not need to be disproved, it needs to be proven in the first place by comparison with the real markets it claims to describe. Many leading economists (e.g. Greg B Davies) have pointed out flaws in it, and EMH is far from being a consensus.
I'm confused. Sumner showed the EMH predicts exactly this, for a certain distribution of information and returns. How is the real world agreeing with Sumner's model evidence against Sumner's model being correct?
What is dangerous about the EMH to me is that it encourages a sort of worship of markets
The EMH is simply a rule which allows you to turn a statistical distribution of new information into a statistical distribution of price movements. This is what Fama did to get the Nobel prize. A corollary is a "speculators can't make money except by chance" theorem, or in it's weak form, "technical traders can't make money except by chance".
It's not a "markets are benevolent wizards that solve all the problems" theorem. It's not a "no recessions ever occur" theorem. It's not a "prices will never change suddenly" theorem - in fact, it proves the opposite of the latter for certain information distributions. If you argue against these latter claims, you are not arguing against the EMH.
it needs to be proven in the first place
That's not how science works. You prove theorems, the best you can do to theories is fail to disprove them.
Sumner showed the EMH predicts exactly this, for a certain distribution of information and returns.
Assuming you are only talking about the blog post you linked, I can't see any sort of proof there, there are some hypothetical numbers about Bitcoin plucked out of the air, and he then goes on to assert that EMH is true whatever happens. If a theory is true whatever happens, it is not a useful model for thinking about the world.
If you take the EMH to mean that prices perfectly (or near perfectly) reflect information (public and private) about an asset, I'd say that mortgage CDOs (to pick a historical example) provide a perfect example of prices NOT reflecting all information - Goldman Sachs insured them with AIG knowing that the prices were incorrect days before the bust, but the price didn't reflect this. Given the incredibly broad claims made by EMH (market prices efficiently reflect all information), one counter-example of corruption, euphoria etc etc driving prices rather than underlying value is enough to disprove it, if it is a meaningful model of markets which can make useful predictions. That is why people cite booms and busts as evidence against EMH, because sudden changes in value are often completely unrelated to the consensus price as measured several days later or before, they are caused by panic, irrational behaviour (in aggregate, not just individually), or insider knowledge; information is so unevenly spread in markets, and manipulation pays so well (e.g. LIBOR), that they are nowhere near efficient.
The grounding of the EMH is a consequence of rational actor theory which assumes perfect information.
It could be true without the rational actor theory more generally or perfect information in particular being true, but there is no reason to expect it to be true except the assumption of those theoretical foundations in which it is grounded.
Its difficult to falsify the EMH, since it doesn't actually rule out any outcomes, it just asserts that if market-beating outcomes occur, they are because of luck rather than strategy. As such, there is no result that is strictly inconsistent with the EMH. (Further difficulties arise since, if one rejects the EMH, but still assumes that market participants do efficiently apply the information that is available to them, any market-beating strategy would need to be kept secret to avoid being adopted generally in the market, and thus no longer be market-beating, so any test of EMH has to be able to distinguish between result of luck and results of covert strategy.)
The existence of Warren Buffett disproves EMH. EMH basically says that beating the market is pure luck as everything is priced efficiently. The fact that WB exists, just one person beating the market for 50 years, disproves EMH. I don't personally have to have an EMH-disproving strategy to see that it isn't true.
"For example, investors, such as Warren Buffett have consistently beaten the market over long periods of time, which by definition is impossible according to the EMH."
This is one of the reasons that it would be very difficult to disprove the EMH even if it were false -- there is no set of outcomes that is strictly inconsistent with the EMH.
No, it doesn't.
There is no length of a run that cannot be luck. If you have a quantifiable expected distribution of results, you can say how improbable it is that you would see a run of a particular size in a given sized universe of data, but the fact that such a run exists in the data doesn't prove that its not luck.
> I'd be willing to bet you'd have a hard time finding anybody credible that would say what Buffett has done is just luck, which is exactly what you are claiming.
Er, no, its not what I'm claiming. In fact, I'm highly skeptical about EMH, to the point of having said that there is no particular reason (except for known-to-be-false assumptions) to assume that it should be true.
On the other hand, I am saying that the claims that it is "disproven" by the existence of runs like Buffet's overstate the degree to which the EMH is even falsifiable.
Most things revert to the mean, and right now the market is substantially above mean, and that market level is based on other aspects of the world that are currently also out of mean.
1. Buy bargains when assets are underpriced.
2. Hold those assets for many years.
Also, Buffet buys substantial or controlling fractions of a company, so the other owners can't scrwwo him. If you can't do that, you can't replicate his large scale success.
In what sense is it "substantially" above mean?
He's not picking companies whose values will go up, he's picking companies he can cause to increase in value by owning them. This is something non-billionaire investors can do, too, but probably not for publicly traded companies.
I know people who do pick stocks exactly as you describe, and they do just fine. But they spend a lot of time and attention on it, and they have years of expertise. The question for me isn't, "Can I do the same," it's, "Can I do something better with my time?" For me, the answer is yes. Trading stocks is making money, but it isn't creating value. I'd rather focus on creating value.
In theory, I get your "What if one day nobody traded stocks? Index funds would be doomed!" point. But in practice I don't think we're near that point. There still seem to be plenty of business news, plenty of business reporting, plenty of people fussing about individual stocks. Indeed, it seems like way more than we need. I don't feel obliged to add to their number.
1) Index market timing. This is easy: allocate your funds among multiple indices Boglehead style, and if an index's P/E is too big, divest from it. This strategy beats the market with almost zero effort. There's tens of trillions of dollars of market cap out there, there's not enough money on Wall Street to reverse the polarity of that.
2) Large stocks subject to large negative sentiment. AAPL when it was at $400, BP, etc.
3) Large stocks subject to large, wildly varying market sentiment, like TSLA. I'm a little afraid to try this with real money, but have been paper trading it with success. You have to have a good mental model of how mass psychology works, and it's easy to get that wrong and lose a lot of $$$.
: Most of these are run by morons. They are suckers for Wall St. sharks in expensive suits.
Think of it this way: look at all the employee stock you hold and ask yourself, "would I ever buy this much stock from this company if I didn't work here?" Of course not. The only reason you have it at all is because you got it in a stock grant or bought it at a substantial employee discount. But now that you have it, it's the biggest individual position you have in the whole market. Where you happen to work is a totally arbitrary consideration relative to where your money should be, so this is a really silly state of affairs. There's just no sound reason for you to be holding it just because someone happens to have given it to you; past events are irrelevant to your present decisions. So execute your options as soon as they vest and buy into no-load ETF or something.
It is actually worse than that. To diversify and reduce your financial risk, your money should be concentrated away from where you work. (Otherwise, for example, if the company goes bankrupt, you lose both your savings and your job!)
That's not quite true: you certainly picked which company to work for, and who'd choose to work for a company they don't believe will be successful?
But greeneggs has it right: you don't want to put yourself into a situation where you lose both your job and your biggest investment tanks.
1. You believe in their mission (e.g working for a newspaper even though that industry is in real trouble)
2. You have constraints around when and where you can work - limited to a certain town, need part-time work
3. They offer a high salary for your specific skills - sure, they might be out of business in a few years but you can make good money for the moment
Majority of yahoo employees since 2004-ish? Or Blackberry after 2009?
1. High frequency trading firms with sub-millisecond latency, who make their money from the bid-offer spread. You can't compete here.
2. Medium term traders who will hold a position for somewhere between hours and weeks. They tend to be looking for statistical regularities to exploit. If they find one, they don't expect it to persist for long - the typical 'half life' of a strategy is around six months. It's not impossible for an amateur to compete here, but be aware that there are thousands (tens of thousands?) of people for whom this is a full time job. Many (most?) of them have backgrounds in quantitative finance, have worked at funds and large investment banks, have PhDs in physics, mathematics, computer science etc. So you should ask yourself why you think you will be able to compete.
3. Long-term traders who are either stock picking, or actively managing a portfolio that might include stocks, bonds, commodities, currencies etc. Some of them are just trying to beat the market, and some are looking for absolute return. All the points in the OP article apply to this case.
I don't want to win, I just want to be in the race (and not lose too terribly much). Much the same as how people like to run in marathons they know they can't win. I suspect it would be an interesting blend of things that I like.
You could argue that the bottom 50% are just the suckers - but of course, those who are worse than them have already been selected out. So the 'losers' you're competing with are either the newcomers, or those who did well in the past but are having a bad spree now.
What is going to be your strategy? If you're just going to apply Black-Scholes, well there are 1000's of people already doing that much better than you ever will. So you need a unique approach - either industry insight that you can quantify somehow, an unexplored statistical approach you know more about than most others.
There's an interesting guide with some suggested reading at
I have one that I am trading profitably and for which I have written a scientific paper which could be published (i.e. I can reasonably explain why the approach works and nobody found it yet).
Still searching for an investor in that space to scale it up; if anyone has ideas or knows who could be interested in seeding such strategies i would be glad about a mail (see profile for contact).
There's plenty of "academic interest" to be had without risking any real cash.
I've linked directly to the articles on quant trading: http://www.quantstart.com/articles#algorithmic-trading
If you just want a hobby, have you considered just doing it as a game? You don't actually have to execute the trades.
If you want to do real money, you might consider whether you think you are prone to a gambling addiction. I've seen some very smart people think they had a great system for beating the market get hooked on the gambling aspect and lose a lot of money. One of them ended up mishandling other people's money; they were lucky to stay out of jail.
"For example, you can think of the market as a random walk with an upward bias."
outch again. If you think of the market as a "random walk" (a well defined mathematical concept) AND have read Taleb, you might want to read him again.
Random walk with a drift is how the trend is described.
I said, "can think of", because you can think of it that way for the purposes of the point. I needed an easy phrase to convey the short-term twitching of the market. If you have a better phrase that sets up Taleb's point, go ahead and suggest it.
Probably the most difficult thing about learning how to invest was mastering my emotions. Investing was incredibly stressful in the beginning, and to say that I waged a war against my own emotions in order to subjugate them so that I could invest properly sounds melodramatic, but that's essentially what happened. Now that I've distilled what I know into a fairly simple system, I don't stress nearly as much over my investments. I have simple rules that I follow, and I've found that as long as I follow them, I stay pretty stress-free, and my picks do pretty well. As soon as I deviate from those rules, however, I begin feeling uncomfortable, my emotions begin swelling up, and that affects my decision-making process. I have a rule for when that happens as well: sell, retreat and regroup.
I keep reading that it's practically impossible to beat the market, but I've done it every year since I began investing. Maybe that's just luck, or maybe I'm just the exception, I don't know, but it honestly isn't even that difficult to do any more. After I put the initial time in to learn the ins and outs of the game (hours perhaps in the thousands) and learned the discipline necessary to invest without letting my emotions and biases get the best of me, it all seems pretty simple. That said, I don't think most people are willing to put in this level of effort into learning the game, and I think that's what separates those who should buy index funds and those who successfully pick individual stocks. It's not impossible to beat the market, but it takes a LOT of effort to get to the point at which it can be done regularly without hastening one towards an early death due to heart failure. Most people's only foray into the marketplace is a purchase of some penny stock that their brother's friend's sister's cousin's broker may have recommended. They lose, and decide to let the professionals handle it. Others put in the time to learn about DCF, the relevant ratios, various investing strategies, etc, but they never learn to master their emotions, and they usually end up doing almost as good as the market, but with much higher levels of stress. Those people end up adopting an ETF strategy. A few expend the effort to cultivate both the knowledge and the discipline to use it effectively, and are able to pick successfully as a result.
My two cents.
Posts such as this one are logical and well-reasoned. There is ample documentation of the basic facts of the situation: chances are you can not beat the market average. Any person who, in the year 2013, is still managing their own investments, in hopes of beating the market averages, probably can not be swayed by a post such as this one.
Who should manage their own investments? One could make an argument in favor of investing that is similar to the argument some people make in favor of gambling: think of it as a form of entertainment. There are also the rare individuals who have some method that has been shown to work and they follow it with great discipline. But aside from those who find it entertaining, like gambling, and those who have a proven track record, people should avoid trading stocks.
But this advice will be ignored.
There are lots of investors and traders/speculators who beat the market. I think this is one of the main reasons people persist in trading despite reading articles/posts like the one of this thread. The key thing these people don't understand, though, is that the number of investors who do beat the market (at any given level of outperformance) is no greater than what is predicted by investment decisions governed solely by chance. In other words, there is no or at least very little evidence that the people who beat the market do so by making use of _skill_ (there is some evidence that skilled investors can expect to outperform the market by a percentage point or so per annum, i.e., small outperformance and few of these "skilled" investors). The statistical analysis of the performance of investors over last half century and more is basis of so-called "efficient market theory" (EMT), which most misunderstand. EMT does not say that investors can't outperform the market. This is obviously false, since many do. EMT says basically that investors should not expect to be able to use skill to outperform market; if they in fact outperform it is the result of chance, and there was equal chance of underperforming the market.
I'm always amused at the number of people who read about EMT and discard it as "obviously false". Do they really think that high-powered intellects have been analyzing this stuff for decades and come up with something that can be rejected by a man-on-the-street as "obviously false"? Hmm, perhaps the man-on-the-street is misunderstanding what they're saying. Two good sources to start with are Malkiel's classic _A Random Walk Down Wall Street_, and William Bernstein's dependable investing guide _The Four Pillars of Investing_.
Some professionals have an edge by developing a model of the market that suits their particular risk levels/cognitive model. As long as that edge continues to work, they continue to outperform by large amounts. The edge might be extraordinary discipline, it might be a allocation size model, it might be a risk-management model. The edge has to exist, and most importantly, it has to match the psychological profile of the individual.
The mistake is not that the EMT is particularly true, it is that amateurs approach the markets with the hope of replicating the results of the professionals, and that amateurs think they have an edge, but they in reality do not.
If the Efficient Markets Theory is to hold true, then in no case should people have multi-year returns well in excess of average. Since this is true, then most people will say that the theory is false. I don't really have a dog in the fight- I don't care either way. But I don't think you can say that it is chance that causes people outperform the market, because there is far too much evidence to the contrary.
As for the 'people studied for years' bit - I don't think that strengthens any argument. The research world is littered with theories that have failed, and length of time spent researching has little correlation with factual correctness. Ultimately, more theories have to fail than succeed in order for knowledge to be gained.
>The chance of this happening due to luck is impossibly low.
The chance of this happening by chance to some investors (though not particular investors) in a sufficiently large group of investors will approach 100%. Also, depending on the density of the relationships between investors and the amount of attention they get for their returns, the odds of one of those investors being within a friend of a friend of yours will also approach 100%.
The existence of runs is not evidence against randomness.
If you flip a coin a hundred times and it comes up heads 98 times, you're probably safe in assuming it's a biased coin.
OTOH, if you flip it several billion times and it has a run of 98 heads, you can't, on that basis alone, conclude that it is a biased coin.
You can't just pull the run out and treat it as if it was the whole universe of data.
The few that exist might be documented (but please enlighten us on where), but if they are, it's most likely because they are so rare.
"I personally invested in a fund 12 years ago which has returned a compound 21% pa return over that period, so I know that they definitely exist."
That's exactly what the GP says - of course there are, but how do you which ones will be, and know you didn't stumble into this one by chance? Your story might just be survivor bias. When I look at the funds my banks offer, there are some that offer 10%+ returns for the last years. Thing is though that they offer dozens of funds, all of which look equally likely in their prospects. How do I know which one to pick? Their yields are normally distributed, just as one would expect.
- One individual or fund doing well in any particular year = random chance
- One individual or fund doing well for a decade = chance is not a possible explanation
Essentially the chance of getting a heads on a coin flip is a 50/50. If you get heads, it's a chance event.
However, if you do 10,000 coin flips and end up with 8,000 heads, either the flipper or the coin have an edge in making heads turn up. The pattern shows that it is no longer a random 50:50 chance.
EMT is probably approximately true, specially with fast algorithmic trading and automated analysis. But the degree of accuracy is key -- some applications are highly sensitive to how good this approximation is, allowing big gains. Also, in practice, there is a "zero sum" part of trading, and that necessarily implies that someone is going to make money and someone will loose (disregarding the other part). Whoever has the best model wins consistently.
"Multi-decade returns of 20% and above"
Do you have any proof of these over the top claims?
I recommend reading http://www.amazon.com/The-New-Market-Wizards-Conversations/d... and the other versions in the series - I think there is 4 now. These are candid interviews with the individuals involved. They are good reading just for the interested entrepreneur.
Also there is a strong selection bias component. People who lose don't usually brag to their friends/news station/co-workers/blogs/twitter, those that beat the market do.
This is the same as lottery. If you had to sit and watch a 1 min clip of everyone who bought a ticket and didn't win, just like people watch those that played and won. Nobody would probably buy lottery tickets. But because of the selection bias, it seems there is always so and so how "made lots of money on the stock market, so why can't you?"
A belief in an efficient market is far from a consensus among professionals.
I personally think it's pretty absurd to claim that markets are efficient given that their behaviour is driven by humans with a lot to gain/lose, and algorithms which are looking for short-term profit, not efficiency, and also given the many acknowledged examples of over-confidence, corruption, bubbles and subsequent crashes over the last few decades.
Yes, because they're idiots. Idiots can feel in their gut truth and no amount of "facts" or logical reasoning can dissuade them.
That said, I do the occasional amateur stock trade with a small amount of funny money. Much to your point and the OP's point, these often go against me despite my hunch. CF my recent purchase of TSLA at $145 ('buying at the bottom') and my recent sale of bitcoin at $350 ('sell before the crash and buy back in').
Another reason -- banks and other places that offer investment as a choice will heavily influence their client to invest. In anything, as long as it pays the fee. "Check out this new investment research tool, you can sort your stocks by such and such feature now". They don't care. They want you to click the "Trade" because they get paid when you do that.
People like this can win at roulette, too.
(Well, for a while.)
Plus once you've had a record of success opportunities come your way that aren't generally available. You try and buy GS preferred stock with a 10% dividend and warrants on top and see how far you get.
Given the vast number of market players, what counts as "statistically significant"? A probability of seeing results at least as good as theirs by chance of 1 in 20? 1 in 100? 1 in 1000? 1 in 10,000?
It really depends how much money you're managing, and whose...
If it's your own money, and it's not a massive amount, you can easily double your money or better every year.
Returns go down as numbers go up, especially when you have clients.
By "easily" do you mean it happens for some measurable number of small-money participants (of which there are many, of course)?
Or do you possibly mean that you invest in 10 different stocks and one doubles?
This sounds like optimism bias.
There is no basis for returns to "go down as numbers go up", except if you are forgetting to average in the losses when the numbers were small. (Maybe because they are small they don't feel like they "count"?)
> By "easily" do you mean it happens for some measurable number of small-money participants (of which there are many, of course)?
I mean a relatively sophisticated trader, one who actually understands markets and understands where he can take advantage of markets, can achieve very high returns if he takes advantage of his, you could call it 'agile' position.
For instance, it's quite common for a stock to gain 1-2 percent per day, and to go on a 10% rally within a week or two. Let's say I'm bullish on a stock. I'll wait for a 5% or so pullback, then watch it on a down day. I see a dip, I'll buy in. I could be up half a percent by day's end. Then, if I'm right, it'll rally up to 10% within 2 weeks.
If I'm investing an 'optimized' amount (ie. one that's small enough to unload quickly, but big enough to make commissions a no-factor), then I can make money on a half-percent move. I can be happy with 2%, and very happy with 5-10%. If you repeat this enough, and have a batting average of 60% or higher (ie. consistently just over half with a very disciplined strategy), the interest compounds when you sell one stock to buy another.
Let's add up numbers in 2 percent moves, times 10 trades. You wind up at ~122 dollars, or 22% percent up from your original amount. 50 trades, you're at 269 dollars. Over double. 50 trades isn't very much for a dedicated trader, and that's not even what you'd call 'day trading'. Compounding interest and math is fun, eh?
> Or do you possibly mean that you invest in 10 different stocks and one doubles?
That would be stupid. Investing isn't about shooting in the dark and hoping you hit something. It's about optimizing your return through solid principles, and not giving a shit about any single stock.
> There is no basis for returns to "go down as numbers go up", except if you are forgetting to average in the losses when the numbers were small. (Maybe because they are small they don't feel like they "count"?)
Volume is everything when trading. If your position in a single stock is too big, you'll have a hard time loading or unloading a position. When you get into managing large amounts of money, it gets more difficult to get in and out of positions, which affects how much of a return you can make.
- I don't quite see how you are factoring in the 60% batting average above (seems like it would water your returns down quite a bit from an average 2% "per move"
- I'm not sure how well I believe that a casual trader can bat 60%. That sounds quite generous to me, especially on short-trades.
I think your ability to execute this strategy as high as 60% is going to vary year-to-year as well, although (thinking out loud), maybe this is a good strategy to play in obvious bull (2013) or bear (2009) markets, but not in flat markets (2012), when it's going to be hard to predict the outcome of any given drop or bounce.
You're right, I was jumping the gun a little. The average gain is actually a bit higher than 2% (probably 3-5%), and if you're disciplined, you can keep your average loss to a percent or so.
The 2% was a more or less arbitrary number to show some of the math behind it, and that you don't need big gains on one trade to make a lot of money.
> - I'm not sure how well I believe that a casual trader can bat 60%. That sounds quite generous to me, especially on short-trades.
Casual, no. A dedicated retail investor, yes.
I agree with the original post that casual investors shouldn't be in individual stocks, but disagree with the notion that a non-professional can't trade.
> I think your ability to execute this strategy as high as 60% is going to vary year-to-year as well, although (thinking out loud), maybe this is a good strategy to play in obvious bull (2013) or bear (2009) markets, but not in flat markets (2012), when it's going to be hard to predict the outcome of any given drop or bounce.
Well this year has been a bull market, so I've batted 100%. My best trade was a 20% gain in less than a week. 60% is what I'd expect over time, though even 40% is workable if you limit your losses and maximize your gains. I also choose stocks based on their relatively predictable price movements, I stay away from over-publicised stocks that trade wildly based on the news.
Flat markets are tougher, but as long as there's some volatility you have opportunity. Learning how to read technical indicators (various statistical indicators based on price movement and volume) is incredibly helpful.
And when I say it's easy, I mean logistically and realistically possible. Few are good enough to make those returns, but it's very possible.
No trader ever expects one stock to double. 5 percent a trade can get you 400 percent a year...
Sorry, but he is correct. If you buy $1000 of a stock, it's a drop in the bucket, it changes nothing. You can buy it and sell it back all day long. Get in quick, get out quick. If a pension fund manager needs to buy $1 billion worth of a stock, the stock's price will have a massive move. It might take weeks or months for the manager to accumulate the required shares. The guy trading $1000 can ride the wave of the fund manager. If the little guy is able to detect that a bigger guy is consistently buying, the little guy can take advantage of that over and over. The bigger guy doesn't have that option to ride the wave of someone bigger.
But compounding gains for a 100% return on a portfolio is very possible, through more active trading.
Think of it this way:
How much can a trader make on a capital of $50k? Answer: $60k
How much can a trader make on a capital of $500k? Answer: $60k
Not literally, but hopefully that paints the picture.
Warren Buffet, a very famous investor you may have heard of, even mentions that he knows plenty of small individual investors who follow many tenets of the philosophy of value investing and they have consistently beat the market.
I, personally, have been individually investing, following the principals of value investing, knowing the companies I invest in, and asset allocation, diversification across industries, and I have slaughtered the market for over 20 years.
All the points he raised in the article are valid, but they read like pop culture one liners. If you are serious about investing I recommend reading Ben Graham's Intelligent Investor and Security Analysis, and follow along with Buffet's letter to shareholders.
Understanding the stock market takes time, and you won't find the answers in a 1000 word blog post.
So, the only reason not to trade is that you should expect to do exactly as well as the market and pay a bunch of transactions costs which makes you strictly worse off, but the Buffet approach doesn't pay more than you would have anyway.
A point not mentioned is that individual investors can have planning horizons 3 to 50 years long while a lot of Wall Street money is on a 3 month put up or shut up investment time frame. Strategies that take a long time to mature are tough to do when you can get performance-fired for not having your thesis pan out fast enough. You don't have that restriction with your own money.
That said, if one is not sensitive to those idiosyncratic risks - ie if they have good job security and/or a large financial cushion - a value tilt can indeed provide an edge over the market. I personally would rather get it with low cost value index funds though, rather than taking on the non-systematic risks of investing in individual stocks.
Mind you, it's much easier to buy index funds and sit on them than actively maintaining a value portfolio which you should be re-examining every 6 months, but it can be very worthwhile.
I ask this as a perfect ignorant, so I don't have a position on this argument: how can you tell?
And if those answers are strong, I'd like to invest some money with them.
If you want to know this group of high performing value investors, c2 is referring to Buffet's article called "The Superinvestors of Graham-and-Doddsville". It's a pretty fascinating read. You'll have a hard time investing in most of these folks as they are all early proteges of Ben Graham (father of value investing) and as such many are dead or retired.
Regardless, I highly recommend reading those as they give you an idea of why some think a strong value investor can beat EMT & the market.
I study the market fundamentals and prioritize the long-term health of a company over short-term profits. I like companies that are never in the news, on the theory that lack of attention lowers demand. I think about long-term economic trends, like the center of US population moving west and the increasing price of oil.
But right now the stock market seems too hot, so I am investing in other assets. Eventually, there will be a bust, stocks will fall and gold will rise, and I will sell gold and buy stocks. Nothing apocalyptic, just the normal business cycle that has been repeating for centuries. Corporate investors do not have the luxury of thinking this far in the future, because their management and clients are focused on quarterly profits. I believe patience is a competitive advantage.
The problem is that for an outsider to whom you are a stranger, the former is overwhelmingly more likely than the latter.
This argument of long-term investment I have heard used pro the German and Italian (sleeping giant) economies, which are dominated by family owned SMEs.
I take it you are not one of them.
Only by selling to people who, at least in my opinion, are likely to lose their shirts.
Besides, BitCoin isn't unique in the "If I had only bought this years ago!" case. Apple made lots of millionaires, too.
Markets are clearly more efficient at the top (and all but the most inclined wont be running their own hedge funds). Buffetts, Paulsons, etc cannot just move into a position on a whim. They thus require more asymmetric information for a trade to make sense.
Inversely, smaller traders avoid the enormous position sizes that can make transacting difficult, and thus can benefit from increased mobility in the markets. This means less lucrative information advantages can be harnessed more easily. Additionally, there are inefficiencies that simply cannot be realized by large funds (see the Norilsk Nickel tender in 2011, "free" money for small investors: http://kiddynamitesworld.com/norilsk-nickel-russian-odd-lot-...).
I'll temper my entire statement by saying I agree with you for 99% of the population, but I do think people too easily punt on efficient market theory. I do believe the small, inclined trader can profit.
That's when I found out about capital gains tax ;) I was very lucky to hit the jackpot like that, and despite winning numerous Australian wide highschool trading competitions (my favourite was a FOREX day trading sim, in real time with the market against teams from around the country in the room with us! Came first with my best friend) to this day I've not invested another cent into the market, for the reasons outline in the article. It's a lot of fun, and I've done well, but I'm not good enough to compete with the big fish; without that, it's too risky, unless I know something they don't!
In the end it was essentially a wash, I did well on those three, lost on most of the others and have never invested in individual stocks ever again. All my investments are in Vanguard index funds.
When I was a #1-ranked stock analyst, I was good enough to put together a winning portfolio of 5 stocks. 2 went bankrupt, but the other 3 did well enough that the whole portfolio doubled in about 1 1/2 years.
But once I no longer worked full-time on Wall Street, I felt I couldn't beat index funds reliably, except in the most special of cases. (E.g., my 1990s Oracle 10-bagger, based on a close relationship with the company; that trade might not even have been legal had Reg FD already been in place.) You can't beat index funds either.
Yes, I did well in the Computer Reselling News public stock-picking contests years later -- but mainly, I was channeling picks from a hedge-fund manager friend.
The stock market is a zero sum game - for every buyer, there should be a seller (whether it's another punter or a broker). for every win, there is a corresponding loss.
As such, the stock market (trading on companies already invested in) is 100% unproductive - it's not doing any useful work (except valuing stocks, if that's useful.)
Therefore, if you want to contribute to humanity, if you want to feel like your job actually accomplishes something, you are literally better off as a Barista at Starbucks, like my 17 year old self, than trading stocks.
The stock market drains too many clever brains from other real industries - it is a tragedy. Think what we could accomplish if return actually reflected value added/economic utility!
(So it is possible to overall make money on shares that are eventually sold for a loss)
Certainly, the current market is not particularly dominated by those stocks. It is an interesting question though, what mechanism for providing large amounts of capital would result in the least whinging?
I do think far too much is made of price fluctuation profit, which is essentially a casino game, rigged to those with better information (i.e. not you) and completely unproductive to boot. I don't see why it should be an industry, nor why trades should count towards GDP.
Receiving dividends isn't buying part of a debt; it's receiving your share of the profits of the company due to ownership.
>when savings interest is puny (as now)
What do you suppose happens when you "save" money? You think your cash just sits in a bank vault? No, it's put to work by capital allocators, using the same methods you find so unappealing. There is nothing "honorable" about "saving" as opposed to buying and selling individual stocks yourself.
>which is essentially a casino game, rigged to those with better information
I think you have an odd view of casino games. Such games reveal all probabilities, but those probabilities are titled against you. There is no unknown information, and you will lose in the long run.
On the other hand, buying a stock in a company requires you to take some educated guesses about the future. What will future earnings be? What will the economy look like? What technological advances will occur? There is far more uncertainty.
At the same time, you know the price you are paying for the stock, and hence, based on your forecasts, can determine whether the company offers a suitable rate of return. What other people are doing is irrelevant.
For a site that is so encouraging towards investing in businesses with good ideas, I don't understand the aversion to doing the same through the stock market.
Apologies, I'm applying my own meta-interpretation of company funding - for a non-profit, ownership consists only of the assets since there will never be profit, by definition, so the market goodwill is defined to be 0. In such a situation, you can still get exactly the same money to change hands as an investment in a for-profit - by calling it debt. The non-profit could pay interest on the debt in the same way as dividends are paid, and so on. These work like non-voting/Preference shares.
I automatically convert "real" terminology into this framework in my head, as I don't really believe groups of people (companies) can be valued philosophically. Apologies for letting it slip out!
> What do you suppose happens when you "save" money?
I am well aware of all this, a savings account is a less risky way of doing the same thing (although you're supposed to be investing in mortgages rather than companies). When savings rates are good, there isn't any need to risk your capital (let the bank do it for you). When rates are bad, you need to take on some of the risk yourself in order to get a good return. My analysis doesn't change.
> For a site that is so encouraging towards investing in businesses with good ideas, I don't understand the aversion to doing the same through the stock market.
But you aren't. If you're buying a new share issue, then sure you are. But if you're buying from someone else in the market, you are not funding the company in any way - they don't get any money out of the transaction - what you are doing is much closer to buying a debt in terms of what money actually changes hands.
My point is that these transactions (putting money in a savings account) are "trades" themselves, and all you're doing is shifting risk around. It isn't a better/worse alternative, it just reallocates the capital, the same way that trading stocks does.
It's the liquidity of the secondary market that makes the primary market possible. That's my point.
You still don't need an entire massive industry for "secondary equity sales" in order to float...maybe. I'm less convinced of my own point now, well done. If I had time to build an economic model to study it, I would.
If I buy at 10 and Sell to you at 15. I am up 50%. You are Even.
You sell at 20. You are now up. And the buyer has yet to lose/gain money.
The whole exercise is just shuffling money between people's accounts, nothing substantive changes in the real world.
To give context to "the less I know" I studied economics (though don't work in that field) and follow financial press from interest. So my low knowledge is probably better than the average public. Based on this low knowlege trading on my broad stroke feelings, as much on gut as anything, and infrequent trading seem to work best. Previously I traded regularily (changing positions several times a week) and followed/analylised daily micro events within or affecting my target companies. I found I did worse and I was trying to understand market sentiment and buy/sell based on short term humps/dips.... which has no logic.
After a couple of years of mixed results, results have been much better by trading when I see those macro events when you feel to your bone the market has got it wrong. And then go in and wait a few months.
As a sample of one I cant say if this is right, and there are several industries that exist implying I'm wrong. But it absolutely works best for me.
Essentially, all I am saying is that if your trading were completely random (and buying based on "broad stroke feeling" and "gut" and "feel to your bone" is essentially random) you would expect to do better the less you trade.
Which is exactly what you are seeing.
It's worked so far. I'll probably get screwed next time the market has a huge crash.
But the market price reflects an average, an expectation. And in certain conditions, it doesn't require much correct information to tip your expectation favorably.
Imagine a theoretical market for a stock where the company will either succeed and be worth a billion dollars, or fail and be worth nothing. Right now the company is trading at a valuation of $10MM. So the "market" thinks the company has a 1% chance of succeeding, right?
It seems to me that any belief you have which a) has some effect on the success probability of this company and b) differs from the average belief of everyone else can be used to update your probability on the overall success of this stock away from 1%, and cause you to want to buy or short the stock.
For example, let's pretend the company were Tesla. You think Elon Musk is a badass, and you think badass founders have a substantially higher probability of their companies succeeding than the base rate. Further, you also think most people don't take this into account as much as you do. Shouldn't you be able to use this information to raise Tesla's success probability above baseline and therefore cause you to want to buy Tesla?
To view this idea another way, imagine the market as a bimodal distribution of people who think the company will succeed and people who think it will fail. Most people fall into one of these two buckets. The market price is "obviously too low" if you're looking from the success bucket, and "obviously too high" if you're looking from the failure bucket. Now, if you have no information you should probably assign the "prior" which is the probability of success as determined by the market, but any information which updates you away from the prior makes the stock a good buy or good sell, I think.
"Think" is a qualifier for speculation. That entire paragraph is just a buildup of speculation that leads you to buy simply based on what you "think" is the right answer. At that point you're no longer basing your decision on fundamentals, but on a gamble.
PS: Go Bruno
failed. (fees to high, stocks went the opposite of the way i bought)
Plan two: Read fundamentals, read stock history, make smart investments, use cheaper trading company
failed. (Stocks go the opposite of the way i bought)
Plan three: Options, Paid Optionetics $5,000 for "education". I would make trade low risk iron eagles, canaries, or whatever the fuck they were.
Fuck the stock market
However, I have personally found only one such moment so far: In 2010 Apple released the iPad. After a few days its success was certain. Takes no genius that a lot of copycats will soon arrive. Now the techie knowledge edge: Is there some common supplier they all need? Energy is important, so they will all use ARM chips. Voila, look at ARM stocks in 2010 following.
Why? Because I like playing the lottery with stocks. On average, I might do slightly worse than the market but I retain the potential for massive, life-changing upside. And that's really all that matters to me.
If I put $100,000 into index funds I might reasonably expect that to be worth $108,000 next year. That would literally not change my lifestyle at all, as it's approximately equivalent to accepting 1 or 2 extra short contracting gigs.
If I put $100,000 into stocks I personally pick, I might unreasonably expect it to be worth $1,000,000 next year. That would definitely change my lifestyle. I can also reasonably expect it to be worth $0, which I'm fine with considering I'm young and gainfully employed.
I just don't see the problem with buying stocks as lottery tickets whose expected value is 1.03% (sub-market) but whose potential value is 1000%.
- You don't have to do the work (you are free to do more work or relax)
- That's one or two gigs every year (until you choose to spend the money)
- The gigs compound: in 9 years, it's 2-4, and in 18, 4-8
I'm just providing an alternate viewpoint, but I don't disparage your right to play "the lottery" this way. I think that's a perfectly valid basis for a personal investment strategy.
As you pointed out, it might be statistically worse, but you aren't interested in the median return, either.
Ideally, my hourly rate also increases, though perhaps not exponentially. Still, I really meant the gigs purely as a comparison point... even $16,000 after 9 years isn't much of a lifestyle difference.
Hmm, if you can reasonably expect to gamble away $100k without much worrying, congratulations, and also this article probably wasn't' written with you mind.
I'd actually argue that a good number of people with $100k savings could easily lose it without much worry because if you're able to save up that kind of money you probably already have a good enough job to replenish your savings after a few years.
It scrapes not only price data but management fees, etc to minimise cost and risk. The goal is not to make profit but just to keep up with the market but at a lower risk.
I bought all of these at the above price points because I am in tech, have a strong sense of where things are going to go, and believed these companies (at the time that I bought them) nailed what the future was (and is) going to be. I obviously did so before others realized that they had, in fact, nailed it :)
I get that I could have lost out, might have gotten lucky, etc. But I would argue that you CAN figure out that a company has really figured out something new, figure it out before others, and then bet on them... and win.
Also: If you bought AAPL at $35.72, your unrealized gain today is more like 1456% (based on a last trade price of 550.06).
Disclaimer: I am also at a business school, so maybe we are all just being sold the same snake oil. I sorta doubt it, though. Both of our schools are respected, and our professors are largely people who have spent a lot of time learning these lessons the hard way.
EDIT: To clarify, this is a question; the article seems to be based on the assumption that the market is perfectly efficient; I am wondering how does the fact that it isn't factor in? I would think that one could make money by being reasonable in the face of unreason.
Is your claim that there is enough "smart" capital to more than counter whatever "dumb" capital exists, and that it is fruitless for individual investors to make any money by betting against moves that seem largely caused by "dumb" capital?
I'm not claiming I personally am smarter than every Wall Street investor combined. I'm claiming that every smart Wall Street investor combined might not have enough total capital to counter all the dumb investors out there, and hence there's money on the table.
I don't know whether my claim is true, but the article doesn't address the effect of "dumb" money.
The OP really doesn't invoke an efficient market at all in his arguments. His argument follows the line of statistical studies (eg http://www.umass.edu/preferen/You%20Must%20Read%20This/Barbe...) of individual investor performance, which conclude fairly uniformly that the average individual investor underperforms the market average, for a variety of emotional, strategic, and competitive (dis)advantage based reasons.
The bottom line of this sort of study/argument is that individual investors tend to act on the belief that they have better information than the market. But, when your opponent is a professional, and you are an amateur, you are going to get beaten more often than not. See evidence in your own comment the belief that you could, in certain situations, understand market behavior just by looking at it: "betting against moves that seem largely caused by "dumb" capital". How could you possibly know that a market move was caused by "dumb" capital? Even if you could, how could you expect to know this better than professionals?
All of this, to be clear, is talking about long term, population-wide averages. Everyone can get lucky once, and some outliers get lucky more than average.
This is similar to a situation where thousands of 'investors' bet on a pseudo-random outcome such as flips of the coin or rolls of dice; an observer would expect that some will win big, and some will lose their entire 'investment', but it is not due to ability or strategy.
It is remotely possible that you are giving liquidity to someone who will invest the money into something useful. Probably not, though, it's a very small demographic.
> You are not giving them money to spend on things with a payoff.
Every time we have a stock market crash I buy once the market seems to be stabilizing again. Then I sit on those shares for years. Then I sell (hopefully before the next crash).
I think we are nearing the next crash, therefore I'll be selling it all again (probably before 2014 or early 2014).
I only buy tech stocks. I don't know the companies in other verticals and I don't have the time or energy to research them.
Individual stocks tend to be pretty good for hedging out your own risk/rewards. For example, I've taken a rule of thumb to not invest into Technology, because I work for a company who is tied pretty strongly to Technology.
Buying "market averages" may have me putting up multiple eggs in one basket. Take SPY for instance, its top holding is Apple right now.
Now, I can buy SPY, and then hedge against technology by buying individual stocks in Coke, Johnson and Johnson, and Plum Creek Timber.
Will I beat market averages? Probably not. But when the technology sector crashes (and one day in the future, it WILL crash again), I may be out of a job... but at least Coke, J&J, and Plum Creek Timber will not crash with me.
I can guarantee that my holdings in SPY (a general S&P Index ETF) will crash in the next "Tech Bubble crash", but I'd be very surprised if my other holdings crashed with it.
There is more to investing than just maximizing your average gains. Minimizing risks, and spreading out your assets by nature reduces the amount of gains you will get... but your financial life may be safer as a result.
With my new spare time I developed software instead, which I sell, and has made me far more dough than my investments ever could.
I was recently introduced to the dividend investing strategy. Basically, you pick big, stable companies with a strong history of paying dividends and increasing them every year, and which are very unlikely to go out of business any time soon. You invest in those stocks over the course of years (using a dollar-cost-averaging strategy or something similar) and set up a dividend reinvestment plan on each. After a few years the dividends should be pretty high and once you decide to end the reinvestment plan and keep the dividends, you have a cashflowing asset.
The problem with investing for appreciation is that it's speculation (i.e. gambling). If you're looking for appreciation then index funds are probably your best bet. The strategy above would probably produce a portfolio where the stocks themselves probably won't appreciate more than the market as a whole, but everything I've read about it says that, between a bit of overall appreciation and lots of dividends, you should end up with a pretty massive return on your investment over time.
Of course, I haven't actually begun investing in this strategy yet, so my input may not actually be useful -- this is just what I've found in my research lately.
If a well-managed stock will not sell better than a poorly managed stock (which is the case if everyone uses "whole market" low load index funds, which seem to be the best performers right now) then there is no longer any incentive for management to manage well.
Now, I'm not saying that you will make money by picking stocks; what little I have in the stock market is in a broad index fund, too. I'm just saying; this isn't a sustainable situation.
Well, if you assume that a hundred percent of management's compensation is in the form of company stock, sure.
I somehow doubt that's the case.