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Why I don't trade stocks and (probably) neither should you (edmarkovich.blogspot.com)
387 points by xyzelement 483 days ago | 310 comments



Well put.

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 [1], 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 [2], 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.

[1] http://en.wikipedia.org/wiki/Loss_aversion

[2] http://www.amazon.com/Fooled-Randomness-Hidden-Chance-Market...

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"Naturally the disservice done students and gullible investment professionals who have swallowed EMT has been an extraordinary service to us and other followers of Graham. In any sort of a contest - financial, mental, or physical - it's an enormous advantage to have opponents who have been taught it's useless even to try." - Warren Buffet

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.

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It's worth noting that that Warren Buffet quote was from an annual letter written in 1988. The retail investing landscape was very different then than now. For quite some time, Buffet has been a strong proponent of index investing. Here's one from that same annual letter, in 1996:

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.

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>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.

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Fair enough - if you enjoy doing it, then it's a hobby and it doesn't matter how much you make. But I certainly wouldn't want to put an entire 7+ (or even 6) figure portfolio in a single stock, or even a handful of them. Say that your analysis is dead-on, but some completely unforeseen event strikes the couple of companies you've invested in. There goes a good chunk of your life savings.

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.

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Rather than a short comment a few different books I could recommend that you might like on this hobby/topic are:

-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...

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Thanks, I'll take a look. I did read the Intelligent Investor years ago and enjoyed it, but honestly between searchtempest, family, and relaxation time, I'm also pretty happy to have a portfolio that can run on autopilot. :)

My top book recommendation BTW would be the 4 Pillars of Investing by Bill Bernstein.

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Ah if you read Intelligent Investor you are ahead of most and The Warren Buffett Way would then just be a light fun rehash read (usually the book I recommend before Intelligent Investor). The Five Rules for Successful Stock Investing at least for me was a good book that explained reading financial reports. I'll check out 4 Pillars of Investing, thanks

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Great counter-point. Just to be clear, I'm not knocking that index funds are a good investment option - I'm knocking the often repeated mantra that if you are going to be lazy, invest in index funds.

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.

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Absolutely. Index funds reduce the burden, but don't absolve you of making decisions. Asset allocation, as you say, is still hugely important. So is geographical diversification.

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Actually Buffet is talking about investing in an index fund VS investing on the advice of an investment professional. He is referring to the same biases of professional investment advisers that the previous poster was referring to. Basically ordinary investors do have an asymmetric advantage over investment advisers and 'professionals'.

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'.

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Yes, I realize he is talking about index funds vs high cost mutual funds or paying an adviser for stock picks. And I agree that direct investing in stocks should be superior to high-cost mutual funds. (In fact, even if we did believe in the EMH, that would only mean the expectation is roughly the same as an index fund, just with a lot more volatility.)

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.

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I still think it's incredibly dangerous for anyone to follow "default advice". If you have had the luck of having investable savings (most of the world doesn't so consider yourself very lucky), please do yourself a favor and educate yourself on your financial goals and options.

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> 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.

Burton Malkiel (of "Random Walk Down Wall Street" fame) responds [1]:

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.

[1] http://money.cnn.com/magazines/fortune/fortune_archive/1999/...

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Stock markets are all about aggregating information about the state of the economy to discover its 'true' state at the current time. A trader makes money, on average, when they have knowledge that the market doesn't about a stock's valuation. By trading based on that information, they introduce it into the market, marginally changing the share price towards a value that incorporates their information.

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.

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>"A trader makes money, on average, when they have knowledge that the market doesn't about a stock's valuation"

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.

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Good point... I confused the terms there. I was referring to an investor whenever I said 'trader' in my previous comment.

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Worth noting that the amount of money in index funds has risen to 24% as of 2012. [1]

[1] http://www.pbs.org/wgbh/pages/frontline/business-economy-fin...

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The truth is we don't know at what point index funds will disturb the efficiency of the market. Malkiel makes a guess at 50% although I think he has an overtly optimistic view of how much rational professionals drive the market.

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.

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I think a blend of your advice and that of the original post is correct.

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.

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Where do you get the idea that the EMH assumes perfect information?

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?

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Perfect information may not have been the right term.

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.

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What empirical data disagrees with the EMH? I also have no idea why you believe the EMH requires investors to agree on the prospects of various instruments. It doesn't. If it did, the EMH would be a "no one ever trades" theorem.

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.

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EMH says more than you can't beat the market. Booms and busts do show inefficiencies.

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?

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The track record of Warren Buffet and a few others is evidence that the EMH is imperfect. The rarity of Warren Buffet-level investors is evidence that it's still pretty accurate.

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.

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I honestly don't understand the proposition that you are making and whether are are actually disagreeing with my previous post or we just have a language issue. My original point was that the EMH is false but that an individual can use it as a reasonable model and therefore are unwise to trade for profit without a particular reason to believe that they have and advantage.

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.

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If you are claiming that the EMH is a good approximation to reality but imperfect, we have no disagreement.

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That is close to my view.

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).

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Could you explain that second sentence a bit? I don't see how EMH being wrong implies that there's a strategy that beats the market.

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.

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The EMH does not assert that people are rational. The EMH can be true even if every single person is irrational.

http://en.wikipedia.org/wiki/Efficient-market_hypothesis

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.

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> "Suppose you have knowledge (e.g., the next iPhone causes cancer) that the market has not incorporated."

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.

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Please try to follow the logic rather than just the talking points. I'm showing jbooth how (not EMH) => exists awesome trading strategy.

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I'm still confused as to what your ultimate point is. Are you saying that nobody has ever made a bet like that before? I made 4x on TSLA earlier this year. I don't claim to have refuted the Efficient Market Hypothesis, I just saw a situation where most institutional investors had a wrong idea and I thought I could beat them.

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.

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>"I made 4x on TSLA earlier this year"

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.

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Yes, I bought TSLA options when the stock was at $30 and sold them for a 4x return. It grew to many more times that, so I could have gotten more.

"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.

tldr; http://ycombinator.com/munger.html

(just kidding, that one is longer)

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This tldr is an extremely interesting essay on wealth, business, and stocks. It is ridiculously long, but takes you amazing places. Definitely worth reading!

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Can we discuss it here?

https://news.ycombinator.com/item?id=6837713

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Would wide swings in the price of an individual stock on no material news not suggest that perhaps the market pricing is not perfectly efficient? (And if it doesn't, then I don't think anything could. I mean, that is one of the primary means you would prove it is not efficient, so if you reject that, then there's not much else I could offer you.)

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The EMH says that the absence of news when news is expected should cause price swings, as well as the presence of news when that news is unexpected. And that the presence of expected news shouldn't cause any price swing.

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Where do you get the idea that the EMH assumes perfect information?

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.

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but to take one specific example - mortgage cdos in the last decade - what about that market was efficient?

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."

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The existence of apparent bubbles does not contradict the EMH.

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.

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Booms and busts are not 'apparent bubbles' in any sense, they are all around us, and cause real movements in the markets regularly.

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.

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Thanks for the response, I think we'll continue to disagree, however perhaps we just have a different evaluation of the efficiency of markets - this is probably a difference of degree, as I doubt you subscribe to the market always being 100% efficient? Specific examples about stock market crashes or extreme movements modelled by EMH would be more persuasive than discussion of Bitcoin, I've attempted to give one below.

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.

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> Where do you get the idea that the EMH assumes perfect information?

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.)

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You seem to say this a lot whenever something about EMH get's posted - https://news.ycombinator.com/item?id=6690838

The existence of Warren Buffett disproves EMH.[1] 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.

[1] http://www.investopedia.com/terms/e/efficientmarkethypothesi... "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."

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Investopedia is incorrect. It is not impossible under EMH for particular investors to consistently beat the market over long periods of time, it is just improbable. Given a large number of investors, however, improbable runs of good and bad luck are near certain to occur somewhere in the system.

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.

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"Long period of time" and "50 years" aren't really the same thing in my book. You can get lucky for awhile. At some point it stops being luck. I'm not sure where that line is, but I am confident though that Buffett has crossed it. 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. Once we accept that he isn't just a lucky guy, EMH is disproven.

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> You can get lucky for awhile. At some point it stops being luck.

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.

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Most professional investors and fund managers do have an advantage using it over naive/amateur investors and yet they rarely beat the market, and when they do it almost never lasts more than a few years. "Use index funds unless your name is Warren Buffet" would be a better summary.

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but is right now a good time to buy into an index fund? Or to buy any stock?

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.

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Isn't the standard advice to not invest unless you can wait 10 years for the ups and down to average out?

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That is common Buffett-style advice. But he also advises that price matters. Matters a lot, in fact.

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There are two sides to buffet style advice:

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.

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Not only that - he's able to affect those long-term returns.

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the mean of what... itself? historically? how do we judge this?

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>and right now the market is substantially above mean

In what sense is it "substantially" above mean?

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Despite Warren Buffet's quote, what he actually does with his investments is nothing at all like stock picking -- he acquires substantial fractions of companies and then uses that control (and his personal brand) to change how those businesses and the markets they operate in run.

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.

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You've described the opposite of what he does. It is widely known that Buffett does not interfere with a newly acquired company's strategy, management, or overall market. His bets are sure bets currently -- as they are.

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He wasn't talking about their management processes, he was talking about their capital structure. And he was right. A lot of the acquired companies have high ROIC, because Berkshire Hathaway at its core is a big insurance company and Buffett's investing is there to increase the book value by investing the float.

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This doesn't sound anything like my understanding of Warren Buffett, this sounds more like Carl Icahn.

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As somebody who has started businesses, the "investing your money in an equity exactly as you would treat investing in a business" strikes me as great advice if you have plenty of time, and bad advice if you don't. Investing in a business is very hard work.

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.

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This is great. Hats off to you sir. I've come to the conclusion that some people are wired the way they are, and there's no changing them. It's also like Buffett says (don't remember the actual quote): either Graham's teachings will resonate with you instantly or they never will.

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Another interesting read in this vein is "Luck Versus Skill in Mutual Fund Performance" by Eugene Fama (who won the Nobel prize in economics this year).[1] He shows that even the most well-informed and intelligent investors cannot predictably outperform the market; some do very well and some do very badly, but this is exactly what you would expect from a large number of market participants pursuing different rational strategies.

[1] http://www.dimensional.com/famafrench/2009/11/luck-versus-sk...

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some do very well and some do very badly, but this is exactly what you would expect from a large number of market participants pursuing different rational strategies

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.

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This is the basis of well known - potentially hypothetical - scam. Send 2^n emails out, half stating that stock X will go up tomorrow, half stating the same stock will go down. The next day, split the addresses that received the correct prediction in half, and repeat.[1]

[1] http://ask.metafilter.com/216295/Is-this-famous-investment-s...

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Derren Brown used this approach to convince people he had a system for predicting the winners of horse races: http://www.youtube.com/watch?v=9R5OWh7luL4

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This happens all the time - a firm will make a number of "exploratory" funds, with the losers being rolled into existing funds and the winners "graduating" to being full funds and promoted aggressively by the firm. (At least according to A Random Walk Down Wall Street, a great book that is very relevant to this thread.)

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There was a joke story based on the same idea.

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.

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If the investment newsletter business is any indication, he shouldn't stop sending letters to those for whom his predictions were wrong.

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That isn't so much a joke as an actual scam that people do. http://scams.wikispaces.com/Stockmarket+Tips

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You've just described the hedge fund industry. Well that and insider trading.

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I've heard that mutual fund companies do this. After a few years, underperforming funds get closed and good performers diversify their holdings until they perform like index funds -- The few years of luck at the beginning are enough to show higher overall returns.

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Darren Brown did a stunt supposedly based on this idea.

https://en.wikipedia.org/wiki/List_of_works_by_Derren_Brown#...

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> 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.

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.

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This exact result is described by Buffet: http://www.tilsonfunds.com/superinvestors.html

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This seems like a foolproof scam because it would be completely legal and guaranteed to work. To make it seem even more legitimate I would set the timeframe to 10 years.

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?

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Good point. But how do you protect yourself from this scam? Do we always have to ignore the track record of every investment fund?

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Yes.

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What if every fund manager had a certain non-zero level of skill - but the market price was such that the mean skill level returned no profit (or the risk free return rate). I guess this is more or less the efficient market hypothesis - except if you follow it through I don't think it says that there is no skill in stock picking - just that the skill is undetectable. Under those conditions a random strategy should do as well as the mean - and the mean return will simply be the average market return.

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Good advice.

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)" [1]. 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.

[1] http://advisorperspectives.com/dshort/guest/BP-130108-Track-...

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I think there are a few opportunities to make money in the market that don't violate the weak efficient market hypothesis. I look for opportunities where there's too much money or market sentiment for Wall Street traders to make things efficient, so the EMH doesn't strictly apply:

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 $$$.

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If you are investing for the long-term (i.e. holding for years) then who is your competition? Mutual funds and hedge funds are totally focused on their quarterly returns. Traders are measured in much shorter time frames. How many professional investors are investing for years? Warren Buffett, university endowments and pension funds [1], rich family funds, and other niches you don't hear about on CNBC. Perhaps the reason index investing works is because it forces people to invest for the long-term and avoid all the cognitive errors you mentioned.

[1]: Most of these are run by morons. They are suckers for Wall St. sharks in expensive suits.

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So how does your argument affect stock options? Once a company IPO'ed they aren't much different from stock from any other company. Do you suggest to sell them as soon as they vest?

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Modulo some tax considerations (specifically, you want to sell them when they'll count as long term capital gains), yes, sell them as soon as you can. Keeping your company stock for a publicly traded company is silly for both the reason above and for another reason that goes one step beyond it: you didn't even pick it!

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.

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"Where you happen to work is a totally arbitrary consideration relative to where your money should be..."

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!)

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Depends on what you consider your risk tolerance to be; you could equally say you're doubling down on the success of the company: "when this place takes over the world, it'll help my career and increase my savings". The real problem is considering your employer part of your investment strategy, combined with the craziness of regular people picking stock market winners, per the article and GP's point.

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> Keeping your company stock for a publicly traded company is silly for both the reason above and for another reason that goes one step beyond it: you didn't even pick it!

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.

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There are plenty of reasons to work for a company that you don't personally think will be successful:

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

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>and who'd choose to work for a company they don't believe will be successful?

Majority of yahoo employees since 2004-ish? Or Blackberry after 2009?

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You probably know a lot more about the company you work for than other companies you might invest in, so that might be one reason to prefer their stocks

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Trading stocks as you said is not for everyone, you should try investing in individual stocks if you can read the 10K.

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Let's please stop this parade of ignorance! Trading is not investing! You can make or lose money with both. That's where the similarities end. One deals with the value of businesses, the other deals with psychology and gambling theory. The two are really nothing alike.

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"I've read The Economist for 20 years. Despite understanding the financial markets better than most..." outch..

"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.

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It's unfair of you to pick the first quote and ignore his mentioning that he worked in finance.

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It's exactly like a random walk except that once in a while the walker gets teletransported.

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So I should take financial advice from a random anonymous internet dude who doesn't understand quoting and can't spell "ouch"?

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.

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>"If you think of the market as a "random walk" (a well defined mathematical concept)"

Random walk with a drift is how the trend is described.

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Great. If you know a little tiny bit about finance then you know that stock prices are not a random walk (with drift or without). A random walk would give you a standard distribution. In reality you are dealing with a fat tail distribution.

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I'm interested in learning more about quant-like involvement in the market, just kind of as a hobby for cold winter nights. Would you say the odds are so bad even that would be foolhardy? I don't need to make money, just have something interesting and not loose too much money.

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There are, broadly speaking, three kinds of quant funds that trade equities -

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.

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you should ask yourself why you think you will be able to compete.

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.

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Well the same questions still hold, don't they. Let's say short-term trading is a zero sum game (it probably isn't, but it's not much in the plus, either - I'd like to be proven wrong though). Then the question becomes - what do you think you have to bring to the game that will put you ahead of the bottom 50%. Or bottom 25%, if you can stomach losses that big. Keep in mind that 90, 95% or so of the people playing your game are professionals with large institutional backing, advanced degrees and years of experience.

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.

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So you need [...] an unexplored statistical approach you know more about than most others.

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).

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I don't know what my strategy would be, because I need to learn more. I'm still trying to decide if I ought to pursue it.

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I expect that you will learn a lot, and much of it will be interesting. Some of it will even be applicable outside of finance. Almost certainly you will lose money (through fees and buying data, if nothing else). If you're okay with that, then go ahead.

There's an interesting guide with some suggested reading at

http://quantivity.wordpress.com/2010/01/10/how-to-learn-algo...

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Sure, and I meant it as a rhetorical question. It's just that that is the first question you need to answer for yourself. For me, I could not objectively (even with the most positive assumptions about boundary conditions) answer it 'yes', or even 'maybe'. But still, apart from the strategy, the question remains - what do you have that few others have. You can answer that for yourself even without having a concrete strategy worked out.

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It's definitely an interesting area. However, I would start with paper trading (as other comments have suggested), as it is extremely easy to lose a lot of money in quant trading if you're not careful.

There's plenty of "academic interest" to be had without risking any real cash.

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Sure, paper trading is a given for at least part of, if not all, of the endeavor.

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If it is in fact purely an academic exercise, I'd recommend doing this using a paper account. Many brokers will allow you trade on a paper account to satisfy your curiosity without putting your wealth at risk.

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If you're interested in learning more (shameless plug), I run a quantitative finance information site.

I've linked directly to the articles on quant trading: http://www.quantstart.com/articles#algorithmic-trading

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I don't pay enough attention to know, honestly. I know people who invest their own money and put a fair bit of time into it; they seem to survive just fine. But they're either angel investors or long-term value investors, and those don't seem like what you're looking for.

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.

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I've been actively investing for about seven years now. I pick my own stocks, and my time frame is generally six months to two years. I consistently win using a simple strategy that is essentially a mix of Peter Lynch's 'buy what you know,' Warren Buffett's value investing, and my own preference for under-the-radar or turnaround plays. I never buy hot stocks, and I almost always take a contrarian macro approach. This works well for me. I've averaged about 15% a year since 2006, vs the market's roughly 6%. I used to think that perhaps I was just being 'fooled by randomness,' and I still suspect that my luck will run out on every new pick, but it never does, or hasn't yet. Occasionally I'll make the wrong decision, but that's the exception, and I have rules in place to minimize the effect of bad decisions when they occur.

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.

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Yes! People want a prescriptive approach, and then they are surprised when they get a random walk. Once you use your brain and develop a meta-approach that you understand why it works (and doesn't), surprise, you beat the market.

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DCF ?

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Discounted Cash Flow, a fairly common type of asset analysis. Also used by Warren Buffett.

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First, as soon as you start using phrases "beating the market" in terms of measuring your performance you get the bozo bit flipped from me. Comparing your performance to the market means nothing since it completely ignores risk. If you take on less risk than an equity fund then you should not automatically be disappointed if this index fund outperforms you. If you are doing no homework, picking stocks by throwing darts at a dartboard, and beat the index fund, then yes, you should be happy.

Second, the question is "what is risk?" Academics will tell you risk is best proxied by volatility (or some measure derived from volatility.) Buffett will tell you this is bs and risk is essentially unmeasurable but can be hedged against by buying assets that seem underpriced through analysis and leaving a margin of safety in the price you buy the asset such that you can reasonably expect to have your principal returned if things go completely wrong. At the end of the day if you know something other people don't know, or can see things that other people can't see, your investments based upon this knowledge or vision can arguably be thought of as less risky as those done by those who don't have this perspective, even if they are the same investment. It's easy to think you are always going to be on the losing side of the trade but I also think that in certain scenarios, individuals can make good investing decisions if they have some specific domain knowledge. At the end of the day, Wall Street analysts are good at understanding and predicting certain characteristics of future cash flows, but are completely blind to things they didn't learn how to model in business school. The individual investor, particularly one who has deep understanding of specific domains, seems to me to have an advantage in certain trades not just because of their knowledge but because of the smaller position sizes they need to take as well.

This blog post presents conventional wisdom about investing that is generally accepted as "the truth" for people who consider themselves reasonably informed and smarter than people who just gamble on stocks. However there are alternative viewpoints on security selection and overall risk management that stand far afield from the "shut up and buy index funds" camp that are not get rich quick schemes and are worth considering. Stock picking or more active investing in general being a fool's errand is far from a open-and-shut case. Buffett has been saying this for decades and basically makes the claim that every year that these "you can't beat the market, the market is efficient" views get perpetuated and magnified is a gift to those who see otherwise. (And his returns speak for themselves.)

http://www.amazon.com/Quantitative-Value-Web-Site-Practition...

http://www.amazon.com/Expected-Returns-Investors-Harvesting-...

http://www.amazon.com/Jackass-Investing-Dont-Profit/dp/09835...

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It's patently false the claim that individual investors generally don't beat the market, or that the ones that do only do so by chance.

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.

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I think the key here is that you are "buying" stocks rather than "trading" stocks. If you invest Warren Buffet style you make a significant investment in a company you think is a good value and you never sell. Thus, your transactions costs are exactly the same as someone buying a broad market ETF and you have more fun at the expense of a little diversification for a while. But once you get to 15 stocks you're basically diversified as long as you didn't industry clump.

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.

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>but the Buffet approach doesn't pay more than you would have anyway.

https://www.google.com/finance?q=NYSE:BRK.A

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Sorry, maybe I wasn't being clear. When I said "Doesn't pay more than you would have" what I meant was "Doesn't pay more [transactions costs e.g. fees and bid / ask spread] than you would have [had you just pursued an indexing strategy" In that light the current price of Berkshire Hathaway isn't particularly relevant because even if I just bought Berkshire stock I would still pay the spread. In fact the current B/A spread on BRK.A is 183218.7-174644 = 8574.7 which is considerably higher in percentage terms than a stock with more volume. Of course that's probably exactly how Uncle Warren wants it given he's let the price go so high with out a split.

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How many value investors actually manage to have positive three-factor alpha[1] though? Sure, adding a value tilt gives you an expectation of beating the market. Doing so on a risk-adjusted basis, after taking into account both increased volatility and the idiosyncratic risks of value stocks, is more difficult.

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.

[1] https://en.wikipedia.org/wiki/Fama%E2%80%93French_three-fact...

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It's patently false the claim that individual investors [that] beat the market (...) only do so by chance.

I ask this as a perfect ignorant, so I don't have a position on this argument: how can you tell?

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Warren Buffet wrote about this a while ago: http://www.tilsonfunds.com/superinvestors.html

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I came here to say exactly this. I have been following Buffet/Graham's value investing principles for ~ 5 years and have well outperformed the market (S&P) in that time span. If you follow their approach, it's pretty clear to see when a valuable company is being undervalued by the market (this was happening a bunch during the '08/09 financial crises).

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.

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>> ... 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 Can anyone tell us who a few of them are? I'd like to know how many of them might exist, how consistently they've beaten the market, and for how long.

And if those answers are strong, I'd like to invest some money with them.

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For a good summary of the value investing philosophy checkout these books: Intelligent Investor by Benjamin Graham Margin of Safety by Seth Klarman

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.

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My sense is that all the people who should read this either won't read it or, if they do, won't understand its message. Over the last 20 years there have been dozens of books, and thousands of articles, pointing out that few people can beat the market averages. Even professional investors, who devote their lives to following the market, only occasionally beat the market.

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.

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"Even professional investors, who devote their lives to following the market, only occasionally beat the market."

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_.

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There are plenty of professional investors who have beaten the market year after year, and by a lot more than single digit percentages. Multi-decade returns of 20% and above are well documented. 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. The chance of this happening due to luck is impossibly low.

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.

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>There are plenty of professional investors who have beaten the market year after year, and by a lot more than single digit percentages. Multi-decade returns of 20% and above are well documented. 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.

>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.

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"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.

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> 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.

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I'd still put a pretty high likelihood that it's biased. A run of 98 in 10 billion flips of a fair coin is vanishingly unlikely.

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"Multi-decade returns of 20% and above are well documented."

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.

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No, you're getting it confused. For a start, the fund that I bought into advertised exactly what they expected (it is based on a computerised trading model, so they know what to expect if it worked). It is not 'chance' that I happened onto a fund - what we are talking about is random chance that anyone can have consistent above-market returns. Certainly it is possible for any one individual to have a chance occurence of a high return one year- the EMT would say that next year the chance is for a loss. When people or firms put together year on year of consistent returns above market, that is no longer chance.

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there are a lot of investment funds out there. even if none possess any skill, it is possible for a few to produce extreme risk-adjusted performance simply by chance.

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Still not getting the point here.

- 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.

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If a fund has 50% random chance of doing well in a particular year, then 1 of 1000 funds will do well for a whole decade purely from chance. There are thousands of funds, so existance of funds with 10/10 good years should expected even if they are purely random.

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No, you are not getting the point. When you do millions of 10000 coin flips, the chance that one of them will be 8000 heads is not 50:50. Look up 'birthday paradox'.

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Exactly, let's not extend the conclusions of the article: it's not that it's impossible to consistently beat the market average, it's just that it's extremely unlikely for the "general public".

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.

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"There are plenty of professional investors who have beaten the market year after year"

"Multi-decade returns of 20% and above"

Do you have any proof of these over the top claims?

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Peter Lynch. He managed the Fidelity Magellan Fund from 1977 to 1990 and averaged a 29% annual return over that period.

http://en.wikipedia.org/wiki/Peter_Lynch#Fidelity

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13 years is not multi-decade.

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I'm surprised anyone would think that 20% returns are over the top - outsized returns in markets are hardly an industry secret. Triple digit returns are not unheard of. Most of the people making big money don't exactly advertise and some are downright reclusive. But they certainly do exist.

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.

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Warren Buffett?

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The only professional investor I am aware of returning 20%pa was Bernie Madhoff, and we all know how that turned out.

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http://en.wikipedia.org/wiki/James_Harris_Simons#Business_ca...

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Perhaps you should look into Warren Buffett. I hear he's pretty good too. Peter Lynch was alright as well.

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> at least very little evidence that the people who beat the market do so by making use of _skill_

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?"

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Isn't it normally referred to as the efficient market hypothesis? You don't have to think investors can consistently beat the market to distrust that hypothesis, and plenty of economists think it is suspect, e.g. behavioural economists:

http://www.economist.com/blogs/freeexchange/2009/08/behaviou...

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.

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The EMT (or EMH) is obviously false in its strongest form. However in a weaker form it is generally accepted even by behavioral finance guys. That is, even many (most?) behavioral finance economists believe market is efficient enough that investors should not expect to outperform the market. Can read a little more and get specific example of behavioral finance guru Daniel Kahneman on this point in Wikipedia article here: http://en.wikipedia.org/wiki/Efficient-market_hypothesis

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> 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"?

Yes, because they're idiots. Idiots can feel in their gut truth and no amount of "facts" or logical reasoning can dissuade them.

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I can't agree enough. Most (95-97%) of my investments are low-cost index funds. My strategy is built roughly off this article (http://www.forbes.com/sites/thebogleheadsview/2011/01/28/thr...), adjusted for what I see as my short, medium, and long term goals (eg okay with some money in riskier, higher-return target assets for retirement savings, some more conservative things for saving for house downpayment, etc).

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').

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The laws of stock markets do not apply to Bitcoin because is not a stock. It looks like money, a store of value, a free public ledger, a decentralized trustless information synchronization network ... it's all of these and probably much more than what we might think of.

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The OP's advice, while phrased in terms of "trading stocks", is relevant to trading any individual financial assets. Not sure why some people have fixated on this as stock-qua-equity-only advice. The same advice applies to trading bonds, forex, options, etc. From a trading perspective, bitcoin is just a ridiculously volatile forex currency.

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> But this advice will be ignored.

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.

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> There are also the rare individuals who have some method that has been shown to work and they follow it with great discipline.

People like this can win at roulette, too.

(Well, for a while.)

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There are a few traders in history that beat the market in a statistically significant way for basically their entire career. It is a small number <20, but they exist. The issue is that everyone thinks "I can do that". Most people can't.

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You'd expect that too. Get enough people flipping coins and a few of them are going to have long streaks of heads.

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.

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one of the best ways to evidence a falsified data set on coin flips is to determine if long enough streaks are not present.

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>There are a few traders in history that beat the market in a statistically significant way for basically their entire career.

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?

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> Even professional investors, who devote their lives to following the market, only occasionally beat the market.

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.

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I'm sorry, but huh?

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"?)

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More detailed response:

> 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.

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I appreciate the detailed reply. I guess I'm naturally skeptical in two areas:

- 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.

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> - 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"

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.

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One word - liquidity. As the numbers go up, it's more difficult to trade since as your transactions become larger there's less potential buyers/sellers at a given price level.

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...

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>There is no basis for returns to "go down as numbers go up"

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.

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There are very few investments that will yield 100% in a single year, let alone consistently. If you know of them, let me know, because I need to reallocate my portfolio.

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Of course, there are no reliable 100% stocks. If there were investing would be easy.

But compounding gains for a 100% return on a portfolio is very possible, through more active trading.

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If it was possible, annualized gains from the stock market would be much higher than 7%. If there was a way to consistently get 100% YOY returns on an investment, someone would be getting rich on it. I'd happily pay someone 20% -- hell, 50% -- of the gains if they could get me 100% growth YOY. Instead, hedge funds have actually underperformed the S&P 500 over the past few years.

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You are talking about something different (investing). Traders take a smaller amount of capital and earn a wage from it. So a talented trader might take $50k and over the course of a year working more than 40 hours per week, making thousands of trades over the course of the year, make a net profit of $60k. That $60k is not compounded. It pays for rent, food, beer.

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.

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I've been beating the market, albeit by only a few percent, for years. I may just be lucky, but I believe my methods give me an edge.

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.

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> I've been beating the market, albeit by only a few percent, for years. I may just be lucky, but I believe my methods give me an edge.

The problem is that for an outsider to whom you are a stranger, the former is overwhelmingly more likely than the latter.

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Normally, being willing to lock up your money for longer gets you the liquidity premium (e.g., term structure of interest rates).

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.

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I sold all my stocks and bought into crypto currencies since they're the next big thing. I even opened up a new credit card to leverage up since you can't get a proper margin account on Mount Gox. I'll be able to pay off my mortgage in a few months at this rate! I suggest everyone wait a couple of days and then do the same thing so that I'll have someone to sell to when I need to realize my profits.

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Are you joking? I honestly can't tell.

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Yes I thought it was obvious from the last sentence (i.e. selling on to the greater fool).

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Bitcoin discussions on Hacker News are subject to Poe's Law.

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>discussions

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Seems like you could create a startup to help other people do the same thing.

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Sell the shovels to the gold-diggers.

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Well played minimax. Well played.

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Speculation is a common strategy, you may win or lose, but believing that it is a 'sure thing' is a bet that markets are irrational, where risk/return models do not apply. You may be right, but this has never been proven, despite ample efforts.

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For all your sass, there are many millionaries now that only bought a few thousands worth of it a few years back.

I take it you are not one of them.

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> there are many millionaries now that only bought a few thousands worth of it a few years back.

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.

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I'm going to be a contrarian on this one.

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.

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Not to mention that the efficient market theory completely fails to explain the most basic boom-bust cycles: http://en.wikipedia.org/wiki/Efficient-market_hypothesis#Cri...

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No one has ever explained the cyclical recessions which we all observe; the efficient markets hypothesis does not directly address it.

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We've been doing a rigorous study of the performance of "the experts" at http://backrecord.com . Some results so far: (1) we have no evidence that anyone (via publicly available statements) can time broad market movements, including people who are widely implied by the media as being able to do so. (2) no evidence that anyone can predict anything on a short timescale (< 1 year). (3) Assuming no selection bias [not necessarily a very good assumption], enough statistical evidence to suggest a minority of market commentators can beat the market on longer timescales that we feel it is worth pushing the study further.

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I was given $2k when in highschool by my grandfather to trade on the ASX. It was an amazing learning experience over the three years I did it. I stuck to mining companies, got very involved in understanding the industry, and had an amazingly lucky break -- one of the first companies I invested in (most of the money I was given, as my admittedly amateur research made it seem like it was undervalued) increased in price 20 fold over the 3 years (and continued well after I sold). I ended up with $25k when I finally sold all of them.

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!

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I learned my lesson in like that as well. When I started college I had about $2k in savings from my summer job and I decided to invest in the market. This was in 2008. I bought a few stocks (AAPL, INTC, GLD and some others) and watched some tank, some rise.

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.

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Completely correct.

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.

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Hang on. I hear everyone recommend against stock trading by rolling out "you don't know more than the market".

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.

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For this to be the case, you would have to know more about the impact on 'badass'-ness on stock performance than the rest of the market, or have non-public information on Musk's 'badass' ways; if neither of these are the case, you are just gambling.

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You only have to know more than half of the market.

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You had me up until "You think Elon Musk is a badass". Yes ETFs and index funds are market averages, and technically doing some due diligence can put you above the average, but will your percentage over the average exceed the opportunity cost of having to research the data in the first place?

"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

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This article focuses on financial reasons not to trade - but there is also an ethical concern.

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!

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Some stocks do pay dividends or otherwise find a way to return earnings to investors.

(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?

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I'm not objecting to people owning stocks for the dividends - buying part of a debt and getting the return on it isn't a bad way to fund stuff, and it is a good way to keep your savings scaled to the economy when savings interest is puny (as now). As the author of this post suggests, the way to do this is to buy into an index-averaged fund.

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.

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>buying part of a debt and getting the return on it isn't a bad way to fund stuff"

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.

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> Receiving dividends isn't buying part of a debt; it's receiving your share of the profits of the company due to ownership.

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.

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>My analysis doesn't change.

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.

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This is not true. Because there is a liquid market for equities, it is possible for companies to IPO into that market, incentivizing entrepreneurs to start companies and for VCs to fund them. High liquidity in the market also leads to higher-resolution pricing, which gives the economy information on where, and where not, to invest.

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I'm not talking about a new share release. I'm talking about the buying and selling of existing shares.

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Right. So am I.

It's the liquidity of the secondary market that makes the primary market possible. That's my point.

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Oh I see. You mean that without the capital gains there's no reasons for VCs to invest in the first place, since listing on the stock market is VCs and founders selling their equity. I agree on that point - but then VCs and founders aren't non-productive; they built a company.

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.

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> for every win, there is a corresponding loss.

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.

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who did you buy from the first time, and what did they pay for the stock? and who bought it?

The whole exercise is just shuffling money between people's accounts, nothing substantive changes in the real world.

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My 6-ish years trading has lead me to the view (to a point) that by knowing less I trade better.

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.

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It sounds like previously you were losing money because your frequent trading generated a lot of transaction costs. Now you trade less frequently, you have removed a lot of drag on your returns.

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.

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It was more exiting at a lower price than I paid that was doing the damage. The problem was, in my view, that I was trying to apply logic to an sentiment market. This won't work on the very short term time scale without some kind of knowledge advantage. Or perhaps I was simply not good at it!

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This is my strategy. I don't care too much about P/E ratio, earnings, etc because most investors don't care either. Wait for a big move and react after the chaos. I also decided against diversifying my portfolio. I used to own 10 stocks, but it was too much information to process. I now never own more than 5 stocks at a time.

It's worked so far. I'll probably get screwed next time the market has a huge crash.

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This is quite true. There is such thing as too much information.

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My original plan to get rich once I got my $60,000 software engineering job was to live in a cheap apartment and use TradeStation to write a program to make me a bunch of money.

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.

failed.

Fuck the stock market

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The article narrowly assumes "trading" stocks to mean purchasing shares based primarily on company fundamentals, in the hope that the share price will rise, and with absolutely no mention of any exit strategy or position sizing/risk management.

Here's a better definition of trading stocks:

The purchase or short sale of shares with the intent of profiting on either upward or downward price movement, based off any of the following:

a) Technical information (market data such as price, volatility, volume, etc).

b) Fundamental information (company financial information)

c) News

d) Premonition

e) Completely random selection

f) Literally anything else, including a combination of the aforementioned.

The vast majority of people who trade completely neglect the concepts of position sizing, exit strategies, or other components of a solid trading methodology. In my opinion, this is due to an unhealthy industry obsession with entry signals.

Entry signals determine when you enter into a position, and that's it. They don't tell you how to stop losing money when the stock moves against you, and they don't tell you what quantity of stock to trade in the first place so that you don't expose yourself to undue risk.

It is possible to construct a profitable trading system that utilizes completely random entry signals. You won't make a lot of money, but most people are surprised by the very notion that something like this is even possible.

For example, say you randomly select 100 stocks to trade, and you allocate 1% of your equity to be risked per position. Your exit signals, assuming they're properly designed, will terminate a position once its losses have reached 1% of your total equity. Conversely, these exit signals will also allow for favorable price movement. In other words, they cut your losses and let your profits run.

If you replaced random stock selection with quality entry signals, the trading system I just described would be even better. Point being, even if you have the sexiest, most profitable stock selection method/entry signals in the world, but you fail to give thought to the other parts of your trading methodology/system, it's very possible, if not probable, that it will fail miserably.

-

Psychology is an absolutely huge component of trading. The best traders, whether they're automated systems traders or discretionary traders, overwhelmingly tend to be utterly emotionally detached from the design and execution of their chosen system or methodology, as well as the outcome. Elation from profits can be just as dangerous as sorrow from losses. Exercising this kind of discipline is incredibly hard in practice.

Top traders also tend to be fiercely independent in regards to the synthesis of the ideas and opinions they hold concerning the market; there's a reason very few people get rich trading on the advice of newsletters.

I tend to agree with the article's premise though, in that that most people are probably better off not trading. Ultimately, markets are wealth transfer mechanisms that tend to concentrate wealth into the hands of the advantaged and competent. If this were anything but, things like high-frequency trading and private firms with vast profits wouldn't exist, or at least not to the degree they do today.

-

As an aside, if anyone has an interest in trading and hasn't read them, I highly recommend Market Wizards: Interviews with Top Traders and The New Market Wizards: Conversations with America's Top Traders, by Jack D. Schwager. They were published in 1993 and 1994, respectively. Although written in a period where automated systems trading was in its infancy (HFT didn't even exist), their value in terms of trading psychology remains intact. Arguably they're even more interesting today, considering they're now period pieces.

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As a techie I think you can beat the market occasionally.

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.

https://www.google.com/finance?q=NASDAQ:ARMH&sa=X&ei=3i6cUsb...

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Despite knowing this to be true, I still actively trade the majority of my investments. (My retirement fund is in low-cost index funds.)

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%.

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> "it's approximately equivalent to accepting 1 or 2 extra short contracting gigs."

Except:

- 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 per year.

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.

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> - The gigs compound: in 9 years, it's 2-4, and in 18, 4-8 per year.

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.

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That's true, and an important point: if you expect your personal earning power to grow at a rate far greater than 8%, then investing your principal now will have little effect one way or the other. But investing later will, so it's good to be prepared with the right strategy for you (whatever that is).

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> I can also reasonably expect it to be worth $0, which I'm fine with considering I'm young and gainfully employed.

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.

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> 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.

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I wrote some R scripts to perform historical data-driven asset allocation for long-only, low-load funds investment for the long term. This seem like a good time to put it here: https://github.com/Quantisan/touzi

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.

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AAPL @ 35.72 (430% gain) TIVO @ 8.48 (51% gain) NFLX @ 33.02 (1008% gain)

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.

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Over that time was also a massive tech bubble. What did the S&P 500 do over that time? A tech fund? Actually, I have that answer. If you bought AAPL on Feb 25, 2008 (or thereabouts, it was the only time in the last 10 years it was around that price) you could have bought an S&P index fund at 1,222. Today, that would be a 50% unrealized gain -- not that great. BUT, were you rebalancing to your optimal portfolio, you would have been continuously selling as it rose. In the crash of 2008, you would have had no choice -- based on your optimal portfolio -- to buy a bunch more S&P, which you would have then tripled. Again, not near your AAPL number, but the risk profile of that investment is also much lower. Add the fact that you have focused on the tech sector because of your perceived knowledge, and that is why you have a higher return. But you are betting on the belief you have in these companies. There is an emotional component. I personally believe AAPL is laughably undervalued at 550, but there are lots of smart people out there -- smarter than I am -- that have much lower price targets and are actively shorting the stock. I have 5 stocks in my portfolio that I believed in -- thought they had something -- and really know the field well -- graduate degree and years of work experience well. Some have panned out, others haven't. Over the long term -- retirement length (>20-30 years) -- index funds and a balanced investment strategy is objectively better.

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.

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I bought AAPL at that price in May of 2005. I held on to it during the crash, buying more in 2008 (when it had gone down a fair amount). And you're right... my total gain (including purchases at the higher price) is 430%. My total for that initial purchase is higher :)

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there are a million people just like you. some percent of them beat the market, and think they are geniuses. others think they were just unlucky, but had a great idea/strategy. all of them are missing the point.

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I had the same approach, and when the bubble burst, my darling stock Priceline tanked to 50cents! I liked them, so I bought more at that price, and did well, but that is sheer luck. Many good companies around that time could not claw their way back up.

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In the tech bubble, were not most of the companies that didn't survive making losses? Seems you could quite easily defend against the possibility of the company being unable to claw their way back by only buying companies that are actually viable.

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Good, profitable companies tanked as well. This was 12-13 years ago, and I am unable to recollect some names. I am sure others here can chime in. Even priceline, arguably, at 50 cents was is not reflective of the soundness of the company.

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I mostly agree, but what of stocks with clear value (say utilities stocks with consistent dividends) that are underpriced due to a market downturn? The market isn't 100% efficient and there are plenty of dumb investors who follow herd mentality.

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.

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The same logic applies from the OP's article. You are assuming in these situations that you know better than the entire brain trust and computational resources of every Wall Street firm that these "stocks of clear value" are underpriced.

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But if that – the unstated assumption that the market is 100% efficient – is true, why do we see herd mentality in the stock market? (Why are SEC regulations in place to prevent runs on a stock?)

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.

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It seems like you are equating the author's argument with the efficient market hypothesis. A few others on this thread have made a similar indication. While conclusions of both the OP and the EMH are similar (you will not/cannot beat the market), the underlying arguments are really pretty different.

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.

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I would compare the stock market to a race track; not every betting man (or woman) is familiar with the horses and track, but if there are a few gamblers who have a reasonably good idea of the odds, they can 'correct' the odds by strategically betting for horses that are under-valued. This works for race tracks, and has never been disproved (or proved) in the stock market.

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There are plenty of ways to generate a consistent return with high dividend stocks, but do they outperform the market as a whole (eg an index fund)?

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Some investors may outperform the market, but it has never been proven this is because of skill rather than simple luck.

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.

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I find the idea of trading stocks on a frequent basis too much work. Therefore I keep it simple.

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.

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This is what Peter Thiel calls indefinite pessimism, where instead of money being invested confidently in companies that can use it, it is being forwarded to abstract financial entities that generate no value. Not something that a single investor could change, more a reflection of a growth crisis.

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Buying shares in a public company is not an investment. You are not giving them money to spend on things with a payoff. You are betting, either that you will get a dividend or that you can find another sucker.

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.

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That's how it looks to you, but stock markets weren't meant to be betting houses.

> You are not giving them money to spend on things with a payoff.

how so?

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I believe the parent comment was meant to point out that buying shares on the secondary market does not transfer any money to the company, but instead transfers money to current(or future) stock holders looking to sell(or sell short) their long position. The company would have already received money from the sale of its stock to primary dealers during the IPO ... so for the most part, all subsequent transactions in the market are between investors/speculators.

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A company can also buy back shares a way of returning value to the shareholder.

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I came to the same conclusion about ten years ago and switched into index funds. So I did ok from the financial perspective but I think the biggest benefit was not having to care so much about the mood swings of the market.

With my new spare time I developed software instead, which I sell, and has made me far more dough than my investments ever could.

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After years of applying the KISS principle to software development I became curious whether others were applying the same philosophy to investing. Random searches for "suckless" and "investing" converged upon softpanorama.org's investing articles. The articles, while rambling and poorly formatted, were both skeptical and simplicity-oriented - a sort of Unix approach to the problem of investing. As a 401k investor, this article in particular resonated with me:

http://www.softpanorama.org/Skeptics/Financial_skeptic/Prote...

I studied the writings for several days and began to question my retirement plan's fees, limited fund selection, as well as my 100%-stock-because-I'm-young approach to investing. Eventually I worked with my company to institute a brokerage window, began holding ETFs rather than mutual funds, and set up a Harry Browne portfolio. While this allocation's performance has been good historically ( http://www.crawlingroad.com/blog/2008/12/22/permanent-portfo... ), 2013's gold tumble has negatively affected returns. Still, cutting out middle men and better knowing what is held is a relief.

Softpanorama.org may convince others to review their finances, or at least give Ksh and Tcl/Tk another try.

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It's a bit misleading.

Stocks are fine, but you won't beat the market, you'll just get it's better rate of return than the banks and many other investments.

Just buy safe stocks and sit on them.

And the important point is, you don't sit on them to out ride the ups and downs.

You sit on them to lower fees. This is the most important part, low fees (And tax advantages)

If fees were actually 0, then randomly(Coin flip) buying and selling everyday is the same as sitting. If you don't get this then you're just gambling(in a bad way)

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For the longest time, this is pretty much what I believed, and so I never touched the stock market, preferring to invest in other assets. And, depending on how your investing mindset, it's still true.

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.

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FYI, there are a couple ETFs that focus on high-dividend companies. I hold a small position in HDV, for instance.

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The interesting bit is that this isn't an equilibrium.

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.

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> 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.

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.

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eh, my point is that the more dollars that are invested 'blind' - the less the stock price will reflect anything actually done by the company.

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I don't think you should trade stocks but buy companies instead. I think there's a mental shift in between stocks & the market and investing in a company.

Owning companies existed before stocks: stock markets grew to add easier funding and liquidity of ownership but I think that these days the markets are way more detached from the actual business the companies are doing than before.

It's my perception that those who buy parts of a company aren't generally interested in the stock market. You could as well buy part of the company privately and there would be no stock market for that particular company. If your calculations say it's likely to be a good investment for you then that holds even if the company is public.

What the stock market seems to provide is lots of noise. You generally don't want to hear any of that. I think that when you do your research on interesting companies, some companies light up, and then you should start investing in those companies as long as the light is up. If it goes out, then you should start selling the stock. To compensate against the market noise, you should buy in smaller chunks and spread the purchases over a longer period of time: this way you don't need to care as much as about the dips and spikes.

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> If your calculations say it's likely to be a good investment for you then that holds even if the company is public.

No, it doesn't because you still have to buy and sell your shares on the stock market, and if you do that at a time when the company is grotesquely overvalued you could end up losing money over a quite long timeframe. And even in a normal case the "noise" of the stock market can easily neutralize the advantages of your fundamental analysis.

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A couple of the statements are inaccurate or a bit hyperbolic:

- "In other words, the answer to "do we believe that our stock selection ability is significantly above average?" has to be a resounding, objectively justified "yes." " -- Actually, our "selection ability" doesn't need to be above average, since the average stock picker is not picking index funds. Index funds are used to proxy the average of the product (market), not the professional investor. Since index funds are the theoretical alternative, that's all we'd need to beat.

- It probably doesn't change the overall point about IPOs, but I don't think having or lacking a "desperation" for money changes anything.

What it all really boils down to is this: virtually all the information is already "baked in" to every stock price out there. There's no guaranteed bet, ever. If you aren't living and breathing the markets, it's extremely unlikely you'll be able to account for the market forces in a way that others haven't already.

So really "the rest of us" are just guessing. The only justification for an amateur to play the markets is for fun - like sitting down at a Blackjack table in Vegas.

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Actually, our "selection ability" doesn't need to be above average, since the average stock picker is not picking index funds. Index funds are used to proxy the average of the product (market), not the professional investor. Since index funds are the theoretical alternative, that's all we'd need to beat.

"The market" is majoritarily made-up of professional investors actively investing. So "The market" is the average result of all those professional investors. So you are saying you have stock selection ability that is above average if you choose to pick individual stocks.

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Here is my 5 cents. You can beat the market, because markets do not efficiently price all available information. The efficient markets theory, however, establishes a baseline and explains how that baseline relates to risk. Basically, you absolutely can beat the market, but it is very difficult and requires a lot of work/effort. Same way that you could create a startup that becomes the next Facebook, but it's very difficult to do that

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You can absolutely beat the index, and it doesn't require any unusual skill to do so as an individual investor.If special skills were required, Vanguard would be the only financial services company. People pushing the Bogglehead philosophy also push the fallacy that owning stocks == trading every day.

On a more serious note, diversity in investment is the key to success, and I include individual stocks as part of a diversity strategy, provided you have the time and inclination to do the work required.

I have 70% of my investments in various index and actively managed mutual funds 10% in cash. The remaining 20% I put in a mix of other assets, mostly individual stocks. (Although I did some metal investments a few years ago.) I spend 3-5 hours a week, mostly while travelling on investing and enjoy doing it. I've been fairly successful, as over the last 10-12 years my annual rebalancing has seen money flow from my 20% fund to the 80%.

Some things you cannot do with a fund. During the 2008 crisis, I pumped cash into investments that were unjustly punished by the crash. So I have a substantial investment in an energy MLP yielding a net yield of about 13%.

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It's strange to me that the "prudent"/"rational" thing to do as a retail investor is to park your money in index funds/ETFs. I don't doubt that it works, but I wonder why.

To me, it's totally irrational. By virtue of being included on an index, a stock spikes in trading volume as all the index funds/ETFs adjust to include it; vice versa if it ever gets removed. These transactions aren't free, in fact the simultaneous dumping/buying of the affected stock serves to drive the price further in the favor of sellers or buyers (i.e, not you). And none of that money is coming from rational investors, it's coming from people with no understanding of the stock market blindly parking their money in index investments, which then blindly spew it across a bunch of blue-chip stocks.

So it seems to me like any stock that's part of an index/benchmark is being inflated by index funds. But as long as people buy into the idea of index investing as smart investing, there's no way to bet against it.

Sounds vaguely bubbly to me.

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Everything this article says is true if you accept the postulate that people only trade stocks to make money. There are other reasons to trade individual stocks, however -- for instance, I often buy stock in companies that I want to support or just have an interest in. I vastly prefer getting a decent return from companies that I want to succeed to an equivalent return from index funds.

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I agree with the general sentiment. However, many studies have shown that selling slightly in the money, at the money or slightly out of the money puts on the S&P 500 actually beats it's returns over the long run. This is because with selling puts, you make money in 4 out of the 5 possible scenarios. If the stock goes up a lot, you win; if the stock goes up a little, you win; if the stock stays flat, you win; if the stock goes down a little, you win (not quite as much, but still positive); if stock goes down a lot, you lose. That's pretty good odds, much better than being long straight-out IMHO.

I mostly sell puts on indexes, but occasionally on stocks that have very high put premiums that I think will at least hold their value. It is riskier and has higher opportunity cost than simply holding indexes, but the potential returns are almost double so it may be worth it. Everyone has to evaluate whether being active or passive investor makes sense for themselves.

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One thing I'd like to mention is using 'you make money in 4 out of 5 scenarios' does not take in to account that each scenario does not have equal probability of occurring nor have weighted risk (how much you can possibly lose) associated with it.

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I think it can be put more bluntly. By trading stocks you are entering an arena filled with professional gladiators. Unless you're their equal, you're going to come out missing several body parts. And simply being smart doesn't begin to make you their equal: these people are smart too, and have been doing this for years.

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Bullshit. I can buy $4000 of GE or wal-mart and just hold it. The chances a company that big failing are near 0. The stocks won't do shit, but they will pay a dividend, which is a hell of a lot more than a savings account interest payment.

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Buying (investing) and trading are different games.

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That is not trading - that is investing.

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Question [and don't make fun of me if this stupid, I don't know much about stocks]: what about stocks that pay dividends. In other words picking stocks not that would go up necessarily and then sell, but rather pick those that pay dividends? Is it better? Still pick ETFs based on dividends and don't touch stocks?

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I've had plenty of times in the past where I just knew some company was going to do really well and their stock would skyrocket. Every time, I wanted to buy stock but didn't know how or didn't have money, and, in fact, in one case I did buy some Apple when they introduced the Nano.

Every single time I was correct, and would have made somewhere between 40-200% profit. I only got the 40% profit out of Apple (because I sold too early), but generally, I seem to have a pretty good eye for this.

The big thing though is: I'm patient. I don't need to invest all the time. I only get this kind of insight every few years, but this kind of profit every few years is still pretty good. Next time I get this kind of insight about something, I'm going in big.

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This blog post gives off the impression that you must beat the market to make money. Given the author's CFA and enrollment at a top business school, I'm sure the author knows this isn't true. But if I didn't know much about the stock market, I'd think it was zero-sum just from reading this blog post.

Nevertheless, I agree with the premise of this blog post, but I think the author should put more emphasis on the difference between passive management and active management.

Passively investing makes sense -- you can earn higher returns if you're willing to take on higher risk. Actively investing is what the author and I have issue with -- picking individual companies rather than trading the market as a whole.

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From what i understand, he's not saying that it's a zero sum game. (atleast i didnt get that impression). His major point is very elegantly summarized in the Cecil and Yves story. If you're one of the early few who recognized the opportunity, then yes, you may benefit from it. Because THAT is when the price of the stock is comparatively more accurate. But if you're late (which means you're the avg case), then by the time you buy the stock, the price has already gone "up" due to people buying a lot of it. Sure, it may still go even further up, (case in point: bitcoins), but you can never be sure of that. So he just means you need to be better than the avg at predicting stuff to make some serious profit (and also to make up for your opportunity cost)

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Here is a very good interview with economist William Sharpe (Nobel prize winner, http://en.wikipedia.org/wiki/William_Forsyth_Sharpe) that also explains why cheap index funds are better for most investors. The whole interview is very interesting (and long) but for the investing theory on why this true, you can just skip to around 30:00 minutes.

https://www.youtube.com/watch?v=pGIzygsvqck

*Edited to include Wikipedia article of Sharpe for those that don't know who he is.

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You cannot convince people to stop going to casinos and play against the odds, imagine convincing them not to pick stocks. I agree 100% with the author but I'm still picking up my stocks and not ready to give up the fun

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Trading stocks on public markets is like playing poker where 95% of your opponents are professionals. You can win, you just have to be damn good. If you're not that good, don't bother coming to the table.

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Poker is a zero-sum game (it's actually even worse if the house takes a cut). Trading stocks is not zero-sum; it is possible for everyone to win.

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It's not possible for everyone to beat the market, which is what counts if you treat it like poker.

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If you look around the table and can't spot the mark, it's you!

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Even if you only invest in low-cost index funds you can usually beat the market by following this advice:

"Be fearful when others are greedy and greedy when others are fearful" - Warren Buffett [1]

That means if the Fed Chairman is talking about "irrational exuberance" sell. If people are talking about another great depression, buy (but only with money that you won't need for the next 15 years).

[1] http://en.wikiquote.org/wiki/Warren_Buffett

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The idea of "beating the market" which refers to beating the S & P index returns is quite flawed. If anyone tries to impose capital protection measures, like a stop loss, then there's a good chance they would underperform the S & P by getting stopped out at inflection points. Thats why I feel looking at risk adjusted returns is critical. How much risk does a buy-and-hold investor accept to see those returns? If the stock market tanks 50% next year, what is your exit strategy?

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I'm not even a dabbler in this kind of stuff but wouldn't it be fair to assume that individuals that invest small ammounts of money ( up to 100k let's say ) could potentially see larger ROI than big investors since big investors change the market prices so much when they trade with tens of millions?

For example in bitcoin if you trade with 5 BTC you could scalp for some nice poket money but you couldn't possibly do this with 10000 btc

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All of us will at some point in time come across an investment opportunity where we can be fairly certain of price movement. The problem is, most people have trouble playing even when they are not certain, or even telling if they are certain. Nor can they discipline themselves to get out of a bad situation. The people who trade successfully all have very high understanding of when to play, and high emotional control.

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Very well put. It is VERY hard to beat the market unless you have inside information. The cost of buying enough stocks to have a broad portfolio is more than a few basis points to a cheap index fund.

Even most active mutual funds fail to beat the market. Many hedge funds fail to beat the broad market. Since the market is a self correcting average, even the top professionals are just that - average.

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How has low cost index investing worked out for the investors in the Japanese Nikkei? Low cost index buying works if you are willing to accept significant drawdowns, similar to 2008-09. Even if one bought index funds alone, its important to have an exit plan. Maybe learn what a simple moving average is and dont be long when price is below it. Risk adjusted returns doing this beats buy and hold.

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Well its been working well for me. I approached it with favorable starting conditions though (CFA/CPA background, young enough to absorb dangers & I play in a market that isn't full of Goldman style players).

That being said I push everyone towards EFTs too unless I can feel this person has a reasonable shot at actually not getting murdered on the market.

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I don't know. If you're a tech-minded person, and you have a decent idea about where technology is headed, you can make some bets that will likely outperform the bets that portfolio analysts are making.

I doubt, for instance, that the effect of Bitcoin was fully priced into the value of Western Union, as soon as Satoshi's paper was published.

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But that means on aggregate of all bet you made, it would still be worse than market average.

Also, that just adds another layer of difficulty altogether. There are probably fewer people that can predict the future of technology than the financial market.

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The problem with buying the index is that you also buy the dogs that go bust.

Also if an index is heavy in say banks as the FTSE 100 was when the recession hit you get hit harder.

You should see shares as an Investment not as trade its the difference between an investor and a speculator go read Grahams (Warren Buffets mentor) Intelligent Investor

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This is good advice, but you should be careful about the index fund you invest in. Some index funds are specific to industries. Some are "synthetic" Some have a cost nearly as high as mutual fund. In those cases you may not be getting the advantages the author is talking about.

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Even better -- try to find a low-fee fund that rebalances for you. Ever do the financial model for never rebalancing v annual rebalancing v continuous rebalancing. Continuous rebalancing's returns are very significantly higher. This is basically Wealthfront's entire thesis.

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That's funny. The shares of GM that I own are up about 40% since I bought them.

I keep wondering if my investment thesis is simply better than the mean, or if I'm due for an ass-whipping in the market. Maybe the answer is 'both.'

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I think the answer is "neither," exactly like the gambler on a hot streak is neither good at roulette or due for a loss.

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I'd suggest for people that are interested in, in fact, trade stocks, to learn about technical analysis. You have way more control over your gains and losses. If you are well disciplined you can "beat the market" quite often.

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Agree with buying index funds. Disagree you shouldn't buy stocks. Buy index funds with your real retirement and long term investment. Buy stocks with money you can afford to lose.

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So, if trading stocks is folly for the vast majority of people, why do so many trade stocks? Is it nothing more than the same reason that people play slots or buy lottery tickets?

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This is a really well thought out post and mostly correct. But there is some logic missing here.

1. Risk vs Reward.

2. Someone's motivation to sell isn't necessarily directly tied to a belief that the stock won't go up. It could be a need for liquidity, risk evaluation, etc. Therefore your choice could very well be a smart one. In essence no, "winner" and "loser" scenario as inferred.

3. There are indeed markers that indicate (and only indicate) the likely movement of a stock based on trends. So you can in fact take a somewhat educated guess as to when you are 'Yves or Cecil', as Ed puts it.

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This also goes for everyone speculating on cryptocurrencies.

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Better title would be about not picking stocks. If you're buying index funds, you're trading stocks by definition.

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That is factually inaccurate. There are a wide variety of ETFs which have non-equity instruments as the underlying assets.

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Well, I did say index fund, not ETF. I assume the article was talking about stock index funds.

I'd add that if you're not smart enough to pick a stock, you're maybe not smart enough to pick a different asset class.

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You can have index funds composed of non-stock assets. Eg Vanguard's Total Bond Market Index Fund https://personal.vanguard.com/us/funds/snapshot?FundId=0084&...

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Asset class correlations are more stable then stock correlations and thus can be used more reliably in portfolio construction. If you are not smart enough to pick a stock or asset classes then your money will whither away.

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Hm, If the other side is GS and you don't have inside info, you better look for a carrier in some other field.

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I agree with the general sentiment. I day-traded for about a year and came out of it concluding that long term stock "investing" is bonkers. Long term in this context means holding a position past market close. I put "investing" between quotes because I came out of the experience thinking that holding stocks past a day's closing bell was nothing short than gambling. Some of the things I saw happening after market close were just scary. The minute people stopped recoiling at insane P/E ratios it went from investing to legalized gambling.

I did very well day trading but it required massive amounts of work. I devoted no less than four hours pre-market-open and another four post-close to research and data analysis. Taking risks was part and parcel of every single trade. Perhaps the toughest things to get used to was to sell everything --and I do mean everything-- before market close in order to avoid having any open positions overnight. It was tough because there were days when you'd close out at a loss. On any give day you could be up several thousand or down just as much.

The reason I concluded intraday trading to be a better idea (assuming you have the time) was that the charts and a number of other data points almost give you all the information you need to trade. You trade a narrow set of stocks that you get to know very well. Each has it's own personality from day to day. You get used to this personality. You look for stocks that don't have crazy volatility or, at the other end of the spectrum, don't put you to sleep waiting for things to happen. With the right amount of action and the enough experience to avoid emotional trading you can pull back, watch the sheep go up and down the charts and play against them. If you are smart, have patience, luck and don't get greedy, you can make money.

Why did I stop? Because the time and effort invested never results in a profit center that you can decouple from. In that sense it isn't any different than being a brick layer: If you stop laying bricks you stop earning money. I was laying bricks sixteen hours a day.

It's that simple. Instead, if you invest a solid sixteen hours per day, Monday through Friday on a business or a career I firmly believe that, in the long run, you'll be far better off.

There are cases where the stock market is a neat place to make lots of money. You don't have to be in the market to take advantage of those. You simply have to be ready, willing and able to do so when the opportunity presents itself. All you are looking for are market crashes. It's that simple. They've happened before and they'll happen again. And, if you are looking for long term passive gains, that's the best time to jump in. Don't bet the farm on it, but be ready and act decisively when it happens. Go against the sheep.

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I couldn't agree more. Paying retail brokers is a rip off. Low cost ETFs are the way to go. Buy HDV ETF.

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I disagree.

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.

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Are there tools to find out about tech companies that have recently IPO'ed? I'm not talking about the most popular ones like FB, Twitter, etc, that the whole press is talking about, but lesser known ones. Or are tech IPO's so rare, that they all pretty much show up on Techcrunch and the like?

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Forget stocks, there isn't enough profit in that. I'm looking for a good futures broker. I want to give him $1,000 in cash and wind up with $100,000 a mere ten months later. It's happened before, why can't it happen to me?

http://en.wikipedia.org/wiki/Hillary_Rodham_cattle_futures_c...

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I'd take it a step further and say the advice in the first paragraph to put most of your money into equity index funds is also a bad idea. Going over a third in equities is questionable from a risk perspective.

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so how come equities have consistently outperformed every other investment YoY since 1930 ? There is no other investment that consistently yields what equities do. Nor does he say what investment one should make instead (because of inflation, you are losing your money simply by having cash).

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actually, at the beginning, he does say that you should invest in low-cost index funds

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