WALL STREET SMARTS, THE BLOG, IS NOW WALL STREET SMARTS, THE BOOK. FULLY EDITED AND REVISED WITH NEW MATERIAL ON AMAZON
Warren Buffett said that once he had purchased a stock, he could forget about the market and its gyrations. Al Frank had the following to say in his classic, Al Frank's New Prudent Speculator:
Still, we do know that markets have fluctuating periods of advancing and declining cycles. Markets become overvalued from time to time and thereafter decline, after which they become undervalued and subsequently advance. Markets alternate: they become overbought, and thereafter sell off, after which they become oversold - which lays the foundation for the next rally. These swings from overbought and overvalued to oversold and undervalued are not neat, nor are the turning points easily predictable, if at all. Market movements are further complicated by the nature of short-term, intermediate-term, and long-term "trends", which sometimes yield conflicting current readings
When technical investors are poring over their charts, what are they looking for? There are any number of signs to be divined by the chartists, but discovering the overall trend of a stock or a market is one of the most popular. Studying moving averages is one of the most basic exercises of the technical analyst. A moving average ("M/A") provides the price history of a stock or a market. Each analyst has his or her favorite time period for looking back. The speculator or trader looking at an individual stock will create a chart showing an M/A for the stock over a set time frame. One of the most basic of these is the 10 day M/A for a stock.
We will create a 10 day M/A for an individual stock since it is easily calculated. It helps to have graph paper on which you can create a vertical line of price numbers and a horizontal time line. Since you are calculating a number which is the average price of a stock over a given 10 day period, your graph will show only that one number (the average price) for the 10 days going backwards (the chosen time frame). For our example, you will keep track of a stock's price over 10 consecutive days. When you have prices for 10 days, add the prices up and divide by 10, which gives you your first average. Note that on your graph. Each day thereafter, you drop the price of the stock 11 days ago and add in the latest price. You then recalculate the average for the new 10 day period and plot it on your graph. Over time, as you do your daily calculations and add the results to the graph, you will start to see one of three trends: the stock is going up, down or remaining unchanged. Technical analysis holds that each of these trends can provide insight into where the stock price may be headed in the future.
Since you are creating your own chart, you can pick any time line for your average: 5, 10, 30, 45, 60 or 200 days or any other number of days of prices. It is a personal decision as to how many days to use in creating your M/A. Regardless of the number of days used, the exercise is the same. You drop the oldest price, add the newest and average them. There is a very good explanation of time periods to use when creating your own M/A on the website, Trading Plan.com. It provides guidance on tailoring your graph to your investment horizon, which is the time period over which you expect to hold your investment. If you will be speculating over the long term, an M/A of 200 days may be what you want. It would be of little value if you are trading on a daily basis since it will not provide the immediacy you need. Conversely, if you intend to trade or speculate over an intermediate period of time (45-60 days), a 10 day M/A does not give you the longer term chart your investment strategy may need.
If the analyst is looking at an entire market, he or she looks to the Advance/Decline Line ("A/D Line"), which is the ratio of the number of stocks in the market going up compared with the number of stocks going down over a prescribed period of time. If there are more stocks rising than falling, then the A/D Line is telling the chartist that the market is on the rise. If the declines exceed the advances, the chart is indicating future declines. We will be looking at the A/D Line in greater depth in a future blog.
You will note that I use the words "speculator" and "trader" in this blog; not "investor." This is intentional, since, as I said in an earlier blog, technical analysis lends itself to short or intermediate periods of holding a stock. For the long term value investor, market moves are seen as less important.
The material from Al Frank's New Prudent Speculator by Al Frank, copyright 1995 by Al Frank, is used with permission of the copyright holders, the heirs of Al Frank.
Comments are always welcome.
Monday, December 19, 2011
Monday, December 12, 2011
Foundations of Technical Analysis
WALL STREET SMARTS, THE BLOG, IS NOW WALL STREET SMARTS, THE BOOK. FULLY EDITED AND REVISED WITH NEW MATERIAL ON AMAZON
I have referred to fundamental investors as gold miners, digging for valuable nuggets of information on a stock and technical investors as hang gliders, riding the winds of market sentiment looking to profit from a stock's updraft or downdraft in price. Technical investors are often referred to as "chartists" since they graph the action of the market and/or individual stocks. They study their graphs of price movement and trading volume, looking for trends which reveal where market levels or an individual stock price might go (up or down) based on past performance.
Technical analysis is grounded in economics. I think that it also relies, arguably, on a basic law of physics. It is governed by the economic law of supply and demand first described in 1767 and borrows from one of the basic tenets of physics: Sir Issac Newton's first law of motion, published in 1687.
The law of supply and demand provides a model for analyzing what affects price in a market. The rules apply regardless of what the item is; consumer goods, commodities, food, tuition for college, airplanes or financial investments. If demand equals supply and buyers and sellers agree on price, the market is in balance, also called economic equilibrium. If such is not the case, the law states that there are four possible outcomes, depending on existing circumstances in a market, for the price of anything for sale:
1. If demand for the item increases (more buyers) and the supply of the item (how many are for sale) remains unchanged, the price will rise.
2. If demand decreases (less buyers) and the supply is unchanged, the price will decrease.
3. If the supply of the item increases (more for sale) and the demand (number of buyers) remains unchanged, the price will decrease.
4. If the supply decreases (less for sale) and the demand is unchanged, the price will rise.
Sir Issac Newton (1642/1643* - 1727) remains one of the most famous physicists of all time. Since I had to take four years of Latin in high school, I can't resist giving you his first law of motion in its original version:
Corpus omne perseverare in statu suo quiescendi vel movendi uniformiter in directum, nisi quatenus a viribus impressis cogitur statum illum mutare.
This is the scholarly version (during Sir Newton's time) of, "A body at rest tends to stay at rest; a body in motion tends to stay in motion, until it doesn't." Technical investors believe that a stock price, whether rising or falling, will continue in that direction for awhile. Their goal is to buy in early on the trend and sell out before it stops. The moment in time at which the trend stops or changes direction is called the point of inflection.
I think the technical form of investing rests on these two principles. We will continue to explore this strategy in further detail in upcoming blogs.
Comments are always welcome.
* I use two dates for Newton's birth year since England's accepted form of annual calendar changed during his lifetime.
I have referred to fundamental investors as gold miners, digging for valuable nuggets of information on a stock and technical investors as hang gliders, riding the winds of market sentiment looking to profit from a stock's updraft or downdraft in price. Technical investors are often referred to as "chartists" since they graph the action of the market and/or individual stocks. They study their graphs of price movement and trading volume, looking for trends which reveal where market levels or an individual stock price might go (up or down) based on past performance.
Technical analysis is grounded in economics. I think that it also relies, arguably, on a basic law of physics. It is governed by the economic law of supply and demand first described in 1767 and borrows from one of the basic tenets of physics: Sir Issac Newton's first law of motion, published in 1687.
The law of supply and demand provides a model for analyzing what affects price in a market. The rules apply regardless of what the item is; consumer goods, commodities, food, tuition for college, airplanes or financial investments. If demand equals supply and buyers and sellers agree on price, the market is in balance, also called economic equilibrium. If such is not the case, the law states that there are four possible outcomes, depending on existing circumstances in a market, for the price of anything for sale:
1. If demand for the item increases (more buyers) and the supply of the item (how many are for sale) remains unchanged, the price will rise.
2. If demand decreases (less buyers) and the supply is unchanged, the price will decrease.
3. If the supply of the item increases (more for sale) and the demand (number of buyers) remains unchanged, the price will decrease.
4. If the supply decreases (less for sale) and the demand is unchanged, the price will rise.
Sir Issac Newton (1642/1643* - 1727) remains one of the most famous physicists of all time. Since I had to take four years of Latin in high school, I can't resist giving you his first law of motion in its original version:
Corpus omne perseverare in statu suo quiescendi vel movendi uniformiter in directum, nisi quatenus a viribus impressis cogitur statum illum mutare.
This is the scholarly version (during Sir Newton's time) of, "A body at rest tends to stay at rest; a body in motion tends to stay in motion, until it doesn't." Technical investors believe that a stock price, whether rising or falling, will continue in that direction for awhile. Their goal is to buy in early on the trend and sell out before it stops. The moment in time at which the trend stops or changes direction is called the point of inflection.
I think the technical form of investing rests on these two principles. We will continue to explore this strategy in further detail in upcoming blogs.
Comments are always welcome.
* I use two dates for Newton's birth year since England's accepted form of annual calendar changed during his lifetime.
Monday, December 5, 2011
You Have to Follow The Money - What Is The Price?
WALL STREET SMARTS, THE BLOG, IS NOW WALL STREET SMARTS, THE BOOK. FULLY EDITED AND REVISED WITH NEW MATERIAL ON AMAZON
Chartists map the action of the investment in which they are most interested. This could be a particular stock, an entire market, a commodity or anything else with a readily available market price. Al Frank was a self avowed value investor. However, he admitted that he did pay attention to some technical analysis to improve the timing of his value investing. He discussed some of the technical investing tools which he used in his career in his book, Al Frank's New Prudent Speculator. To him, the following summarized technical analysis:
When an equity issue - a common stock, preferred stock, or master limited partnership - trades, only one of three things can happen with its market price. At that day's close each issue can have advanced, declined, or remained unchanged in price compared to its previous close (not necessarily the previous day)...Advancing-in-price issues represent buying - or at least more buying than selling at the moment - on the basic notion that an excess of buyers over sellers (or greater demand than supply) tends to bid up prices. Conversely, selling is represented by stocks declining in price. On any given day the fluctuations represented by buyers and sellers often appear to be random, as orders pour in from all over the world, some to trade "at the market" (the current asking price) or at a price limit with the trader hoping to to get a better deal than the current bid or ask price of a sale or a purchase.
Notice the gentle jab Frank takes at Random Walk proponents.
There is a book which is considered by many to be the bible of technical analysis; much like The Intelligent Investor by Benjamin Graham is widely seen as the bible of fundamental analysis. Technical Analysis of Stock Trends was coauthored in 1948 by Robert D. Edwards and John Magee. Its 8th and 9th editions, both edited by WHC Bassetti, are still in print today. Some consider the following excerpt from the book to be the all time best description of technical analysis:
The market price reflects not only the differing fears and guesses and moods, rational and irrational, of hundreds of potential buyers and sellers, but it also reflects their needs and resources - in total, factors which defy analysis and for which no statistics are obtainable. These are nevertheless all synthesized, weighted and finally expressed in the one precise figure at which a buyer and seller get together and make a deal. The resulting price is the only figure that counts.*
If you look back at the advice of the value investors, you will see that, for the most part, they recommend investing for the long term. It seems to me that, given the daily movement of the market, technical analysis looks at a shorter time horizon. It appears to be more of a tool for speculation, looking for a profit within days, weeks or months - not an appreciating investment over several years. We will continue to explore this strategy in further detail in upcoming blogs.
The material from Al Frank's New Prudent Speculator by Al Frank, copyright 1995 by Al Frank, is used with permission of the copyright holders, the heirs of Al Frank.
*Excerpt from Technical Analysis of Stock Trends, by Robert D. Edwards & John Magee, copyright 1948 by Robert D. Edwards & John Magee, page 5.
Comments are always welcome.
Chartists map the action of the investment in which they are most interested. This could be a particular stock, an entire market, a commodity or anything else with a readily available market price. Al Frank was a self avowed value investor. However, he admitted that he did pay attention to some technical analysis to improve the timing of his value investing. He discussed some of the technical investing tools which he used in his career in his book, Al Frank's New Prudent Speculator. To him, the following summarized technical analysis:
When an equity issue - a common stock, preferred stock, or master limited partnership - trades, only one of three things can happen with its market price. At that day's close each issue can have advanced, declined, or remained unchanged in price compared to its previous close (not necessarily the previous day)...Advancing-in-price issues represent buying - or at least more buying than selling at the moment - on the basic notion that an excess of buyers over sellers (or greater demand than supply) tends to bid up prices. Conversely, selling is represented by stocks declining in price. On any given day the fluctuations represented by buyers and sellers often appear to be random, as orders pour in from all over the world, some to trade "at the market" (the current asking price) or at a price limit with the trader hoping to to get a better deal than the current bid or ask price of a sale or a purchase.
Notice the gentle jab Frank takes at Random Walk proponents.
There is a book which is considered by many to be the bible of technical analysis; much like The Intelligent Investor by Benjamin Graham is widely seen as the bible of fundamental analysis. Technical Analysis of Stock Trends was coauthored in 1948 by Robert D. Edwards and John Magee. Its 8th and 9th editions, both edited by WHC Bassetti, are still in print today. Some consider the following excerpt from the book to be the all time best description of technical analysis:
The market price reflects not only the differing fears and guesses and moods, rational and irrational, of hundreds of potential buyers and sellers, but it also reflects their needs and resources - in total, factors which defy analysis and for which no statistics are obtainable. These are nevertheless all synthesized, weighted and finally expressed in the one precise figure at which a buyer and seller get together and make a deal. The resulting price is the only figure that counts.*
If you look back at the advice of the value investors, you will see that, for the most part, they recommend investing for the long term. It seems to me that, given the daily movement of the market, technical analysis looks at a shorter time horizon. It appears to be more of a tool for speculation, looking for a profit within days, weeks or months - not an appreciating investment over several years. We will continue to explore this strategy in further detail in upcoming blogs.
The material from Al Frank's New Prudent Speculator by Al Frank, copyright 1995 by Al Frank, is used with permission of the copyright holders, the heirs of Al Frank.
*Excerpt from Technical Analysis of Stock Trends, by Robert D. Edwards & John Magee, copyright 1948 by Robert D. Edwards & John Magee, page 5.
Comments are always welcome.
Monday, November 28, 2011
Conflicting Commentary on Technical Analysis
WALL STREET SMARTS, THE BLOG, IS NOW WALL STREET SMARTS, THE BOOK. FULLY EDITED AND REVISED WITH NEW MATERIAL ON AMAZON
You may recall Burton Malkiel's discussion of some research done on technical investing in last week's blog. He said that the results showed little, if any, correlation between past and future prices of stock. So, we know that Professor Malkiel does not hold much store in technical analysis. A proponent of technical analysis might, rightly, ask for more details about the scope of the tests.
Norman G. Fosback, a well respected investment adviser and co-founder of The Institute of Econometric Research, disagrees with him. Fosback's enduring work, Stock Market Logic, A Sophisticated Approach to Profits on Wall Street, was first published in 1976. The twenty-second edition was printed in 1993. In his book, Mr. Fosback took random walkers, such as Professor Malkiel, to task. He criticized the academic studies on which their conclusions about technical analysis were based; writing that the research conducted by them was superficial and not done in sufficient depth to support their conclusion that market timing was of no value. His research led to a different conclusion. In referring to a table of daily price/volume relationships for the period 1965-1972 depicted in his book, he wrote:
The most important conclusions to be gleaned from the table are: (1) rising price is a relatively bullish portent for future price changes and falling price is relatively bearish; (2) rising volume is even more bullish and falling volume is relatively bearish; (3) rising price accompanied by rising volume is the most bullish of all and falling price accompanied by falling volume is consistently bearish. Almost all price/volume tables created with alternative averaging and change parameters, be they in terms of days or weeks, and the author has created dozens of them, show similar results and lead to identical conclusions.*
Based on his research, Mr. Fosback concluded that there was a correlation between historical price and volume levels with future price movement.
There are two types of research: deductive and inductive. The researcher either starts with a hypothesis and finds supporting facts (deductive) or starts with facts and finds the resulting hypothesis (inductive). They are mirror opposites. Mark Twain popularized the statement, "There are three kinds of lies: lies, damn lies and statistics." Depending on your level of cynicism, this may be one of the truest statements ever made.
I suspect that you can find research results to support just about anything you want. As individual investors, we must decide what form of investing works best of each of us and stick to it. Consistent application of an investor's chosen strategy is the only way to improve the results of his or her portfolio.
We will continue looking at technical analysis in the next blog.
* Excerpt from Stock Market Logic, A Sophisticated Approach to Profits on Wall Street, Norman G. Fosback, copyright 1976, 1993, The Institute for Econometric Research, page 148
As always, comments are welcome.
You may recall Burton Malkiel's discussion of some research done on technical investing in last week's blog. He said that the results showed little, if any, correlation between past and future prices of stock. So, we know that Professor Malkiel does not hold much store in technical analysis. A proponent of technical analysis might, rightly, ask for more details about the scope of the tests.
Norman G. Fosback, a well respected investment adviser and co-founder of The Institute of Econometric Research, disagrees with him. Fosback's enduring work, Stock Market Logic, A Sophisticated Approach to Profits on Wall Street, was first published in 1976. The twenty-second edition was printed in 1993. In his book, Mr. Fosback took random walkers, such as Professor Malkiel, to task. He criticized the academic studies on which their conclusions about technical analysis were based; writing that the research conducted by them was superficial and not done in sufficient depth to support their conclusion that market timing was of no value. His research led to a different conclusion. In referring to a table of daily price/volume relationships for the period 1965-1972 depicted in his book, he wrote:
The most important conclusions to be gleaned from the table are: (1) rising price is a relatively bullish portent for future price changes and falling price is relatively bearish; (2) rising volume is even more bullish and falling volume is relatively bearish; (3) rising price accompanied by rising volume is the most bullish of all and falling price accompanied by falling volume is consistently bearish. Almost all price/volume tables created with alternative averaging and change parameters, be they in terms of days or weeks, and the author has created dozens of them, show similar results and lead to identical conclusions.*
Based on his research, Mr. Fosback concluded that there was a correlation between historical price and volume levels with future price movement.
There are two types of research: deductive and inductive. The researcher either starts with a hypothesis and finds supporting facts (deductive) or starts with facts and finds the resulting hypothesis (inductive). They are mirror opposites. Mark Twain popularized the statement, "There are three kinds of lies: lies, damn lies and statistics." Depending on your level of cynicism, this may be one of the truest statements ever made.
I suspect that you can find research results to support just about anything you want. As individual investors, we must decide what form of investing works best of each of us and stick to it. Consistent application of an investor's chosen strategy is the only way to improve the results of his or her portfolio.
We will continue looking at technical analysis in the next blog.
* Excerpt from Stock Market Logic, A Sophisticated Approach to Profits on Wall Street, Norman G. Fosback, copyright 1976, 1993, The Institute for Econometric Research, page 148
As always, comments are welcome.
Monday, November 21, 2011
Technical Analysis - Hang Gliding / Burton Malkiel's Opinion
WALL STREET SMARTS, THE BLOG, IS NOW WALL STREET SMARTS, THE BOOK. FULLY EDITED AND REVISED WITH NEW MATERIAL ON AMAZON
When I finished the blogs on fundamental analysis, I posted a blog with Professor Burton Malkiel's comments on this investment strategy from his excellent book, A Random Walk Down Wall Street. We are about to start exploring the technical form of analysis, which I referred to as "hang gliding" in an earlier blog. To mix things up, this time I will start with his comments and then move on to books by proponents of this form of investing.
Although he describes it accurately, he does not have much respect for the technical form of investing. This is how he described it:
Technical analysis is essentially the making and interpreting of stock charts. Thus its practitioners, a small but abnormally devoted cult, are called chartists. They study the past - both the movements of common stock prices and the volume of trading - for a clue to the direction of future change.....Charts, of course, tell only what the other players have been doing in the past. The chartist's hope, however, is that a careful study of what the other players are doing will shed light on what the crowd is likely to do in the future.
Malkiel referenced results of some research into technical investment rules. He reported the following:
One set of tests, perhaps the simplest of all, compares the price change for a stock in a given period with the price change in a subsequent period. For example, technical lore has it that if the price of a stock rose yesterday, it is more likely to rise today. It turns out that the correlation of past price movements with present and future price movements is slightly positive but very close to zero. Last week's price change bears little relationship to the price change this week, and so forth. Whatever slight dependencies have been found between stock price movements in different time periods are extremely small and economically insignificant. Although there is some short-term momentum in the stock market, as will be described more fully in Chapter Ten, any investor who pays transaction costs cannot benefit from it.
As I said, Professor Malkiel does not hold technical analysis in high regard. Nevertheless, we will learn about technical investing in subsequent blogs and will return to A Random Walk Down Wall Street for more of Professor Malkiel's discussion of this strategy.
The material from A Random Walk Down Wall Street
by Burton G. Malkiel, copyright 1999, 1996, 1990, 1985, 1981, 1975, 1973 by W.W. Norton & Company, Inc is used with permission of W.W. Norton & Company, Inc.
Comments are always welcome.
When I finished the blogs on fundamental analysis, I posted a blog with Professor Burton Malkiel's comments on this investment strategy from his excellent book, A Random Walk Down Wall Street. We are about to start exploring the technical form of analysis, which I referred to as "hang gliding" in an earlier blog. To mix things up, this time I will start with his comments and then move on to books by proponents of this form of investing.
Although he describes it accurately, he does not have much respect for the technical form of investing. This is how he described it:
Technical analysis is essentially the making and interpreting of stock charts. Thus its practitioners, a small but abnormally devoted cult, are called chartists. They study the past - both the movements of common stock prices and the volume of trading - for a clue to the direction of future change.....Charts, of course, tell only what the other players have been doing in the past. The chartist's hope, however, is that a careful study of what the other players are doing will shed light on what the crowd is likely to do in the future.
Malkiel referenced results of some research into technical investment rules. He reported the following:
One set of tests, perhaps the simplest of all, compares the price change for a stock in a given period with the price change in a subsequent period. For example, technical lore has it that if the price of a stock rose yesterday, it is more likely to rise today. It turns out that the correlation of past price movements with present and future price movements is slightly positive but very close to zero. Last week's price change bears little relationship to the price change this week, and so forth. Whatever slight dependencies have been found between stock price movements in different time periods are extremely small and economically insignificant. Although there is some short-term momentum in the stock market, as will be described more fully in Chapter Ten, any investor who pays transaction costs cannot benefit from it.
As I said, Professor Malkiel does not hold technical analysis in high regard. Nevertheless, we will learn about technical investing in subsequent blogs and will return to A Random Walk Down Wall Street for more of Professor Malkiel's discussion of this strategy.
The material from A Random Walk Down Wall Street
by Burton G. Malkiel, copyright 1999, 1996, 1990, 1985, 1981, 1975, 1973 by W.W. Norton & Company, Inc is used with permission of W.W. Norton & Company, Inc.Comments are always welcome.
Monday, November 14, 2011
Word Of Mouth - Stock Tips
WALL STREET SMARTS, THE BLOG, IS NOW WALL STREET SMARTS, THE BOOK. FULLY EDITED AND REVISED WITH NEW MATERIAL ON AMAZON
Robert J. Shiller, in his excellent book, Irrational Exuberance, wrote about the innate human trait of sharing information, especially in person to person exchanges:
The human mind is the product of evolution almost entirely in the absence of the printed word, e-mail, the Internet, or any other artificial means of communication. Human society has been able to conquer almost all habitats of this planet primarily because of its own innate information processing ability. A fundamental component of this information processing ability is effective communication of important facts from one person to another.
This superior ability to communicate knowledge has been made possible over the past few million years by evolutionary changes within the human brain that have optimized the channels of communication and created an emotional drive to communicate effectively. It is because of this emotional drive that most people's favorite activity is conversation.....The incessant exchange of information is a fundamental characteristic of our species.
Word of mouth transmission of ideas appears to be an important contributor to day-to-day or hour-to-hour stock market fluctuations, even though direct word-of-mouth transmission cannot proceed across the nation as fast as markets move.
Human communication is basically the sharing of knowledge; something that has been going on between people since language first developed. Any time two or more people meet, they communicate; they pass information of one sort or the other. In light of the inherent uncertainty in the market, individual investors are always open to information that is seen as reducing investment risk. You must remember that any such information, regardless of how presented, can be only one of three things: fact, rumor or opinion.
As human beings, we strive to learn things in order to reduce life's uncertainty. As investors, however, we must resist the urge to act upon one form of communication: the stock tip. In the last post, we ended with the caution against gambling on Wall Street. One type of market gambling is investing on a tip from someone. Usually that person will claim some inside information; facts not generally available to the investing public at the time. The investor needs to "go slow" when presented with a tip. Facts and rumors can be checked out. Opinion is just that, which makes it no better than an investor's personal analysis of a situation. Opinions differ. As they say, "That's what makes a horse race." The investor must weigh the other's opinion against his or her own information. If the tip is truly inside information, acting on it is illegal in the USA. Investors can't hide their trades from the government computers monitoring the market.
Although recounted in an earlier blog about Philip Carrett's book, The Art of Speculation, I feel his advice on "inside information" is worth repeating. Avoid "inside information" as you would the plague. Looking at the psychological aspects of "tips", Mr. Carret said that they appealed to an investor's vanity since such confidential news sets the recipient apart from the rest of the market. He recommended that the investor view him or herself as being the thousandth rather than the first or second person to get the story. Such lack of self pride would, in Mr. Carrett's view, be "well rewarded."
SHILLER, ROBERT J.; IRRATIONAL EXUBERANCE, copyright 2000 Robert J. Shiller, published by Princeton University Press, Reprinted by permission of Princeton University Press.
The The Art of Speculation by Philip L. Carret, remains in print today.
Comments are always welcome.
Robert J. Shiller, in his excellent book, Irrational Exuberance, wrote about the innate human trait of sharing information, especially in person to person exchanges:
The human mind is the product of evolution almost entirely in the absence of the printed word, e-mail, the Internet, or any other artificial means of communication. Human society has been able to conquer almost all habitats of this planet primarily because of its own innate information processing ability. A fundamental component of this information processing ability is effective communication of important facts from one person to another.
This superior ability to communicate knowledge has been made possible over the past few million years by evolutionary changes within the human brain that have optimized the channels of communication and created an emotional drive to communicate effectively. It is because of this emotional drive that most people's favorite activity is conversation.....The incessant exchange of information is a fundamental characteristic of our species.
Word of mouth transmission of ideas appears to be an important contributor to day-to-day or hour-to-hour stock market fluctuations, even though direct word-of-mouth transmission cannot proceed across the nation as fast as markets move.
Human communication is basically the sharing of knowledge; something that has been going on between people since language first developed. Any time two or more people meet, they communicate; they pass information of one sort or the other. In light of the inherent uncertainty in the market, individual investors are always open to information that is seen as reducing investment risk. You must remember that any such information, regardless of how presented, can be only one of three things: fact, rumor or opinion.
As human beings, we strive to learn things in order to reduce life's uncertainty. As investors, however, we must resist the urge to act upon one form of communication: the stock tip. In the last post, we ended with the caution against gambling on Wall Street. One type of market gambling is investing on a tip from someone. Usually that person will claim some inside information; facts not generally available to the investing public at the time. The investor needs to "go slow" when presented with a tip. Facts and rumors can be checked out. Opinion is just that, which makes it no better than an investor's personal analysis of a situation. Opinions differ. As they say, "That's what makes a horse race." The investor must weigh the other's opinion against his or her own information. If the tip is truly inside information, acting on it is illegal in the USA. Investors can't hide their trades from the government computers monitoring the market.
Although recounted in an earlier blog about Philip Carrett's book, The Art of Speculation, I feel his advice on "inside information" is worth repeating. Avoid "inside information" as you would the plague. Looking at the psychological aspects of "tips", Mr. Carret said that they appealed to an investor's vanity since such confidential news sets the recipient apart from the rest of the market. He recommended that the investor view him or herself as being the thousandth rather than the first or second person to get the story. Such lack of self pride would, in Mr. Carrett's view, be "well rewarded."
SHILLER, ROBERT J.; IRRATIONAL EXUBERANCE, copyright 2000 Robert J. Shiller, published by Princeton University Press, Reprinted by permission of Princeton University Press.
The The Art of Speculation by Philip L. Carret, remains in print today.
Comments are always welcome.
Monday, November 7, 2011
Who The Hell Are You? (2)
WALL STREET SMARTS, THE BLOG, IS NOW WALL STREET SMARTS, THE BOOK. FULLY EDITED AND REVISED WITH NEW MATERIAL ON AMAZON
Having cleaned up the birthday cake crumbs from last Monday's anniversary blog, we pick up the topic of investment vs. speculation from my October 24th blog. We have seen how Philip Carrett and Benjamin Graham addressed the subject. Al Frank in his book, Al Frank's New Prudent Speculator, wrote about the two words, but felt that the difference was more about semantics than investment strategy. He cited a dictionary definition of speculation:
Engagement in any business transaction involving considerable risk for the chance of large gains.
In contrast, the same dictionary defined investment as follows:
The investing of money or capital for profitable returns.
Frank pointed out the absence of the words risk, chance or large gains in the definition of investment. He wrote about this obvious bias: speculation = risky and investment = safe; a viewpoint with which he totally disagreed. He explained his position as follows:
Right off, let us agree to a stipulated definition that all so-called investing in common stocks is a form of speculation. I believe it is important at the outset, throughout the pages of this book, and indeed in our everyday thinking about the stock market, to be aware and admit that when we trade stocks or buy them for their long-term potential, we are speculators.
The point of this discussion is not to clarify the distinctions being drawn by these authors, but to suggest that you, as an individual investor, must ask yourself a question before you buy a security. Regardless of how you may define the words, are you thinking like an investor, a speculator or a gambler? In any event, whether you are looking for long term appreciation or quick profit, you should save the gambling for Las Vegas, not Wall Street.
The material from Al Frank's New Prudent Speculator by Al Frank, copyright 1995 by Al Frank, is used with permission of the copyright holders, the heirs of Al Frank.
As always, I welcome your comments.
Having cleaned up the birthday cake crumbs from last Monday's anniversary blog, we pick up the topic of investment vs. speculation from my October 24th blog. We have seen how Philip Carrett and Benjamin Graham addressed the subject. Al Frank in his book, Al Frank's New Prudent Speculator, wrote about the two words, but felt that the difference was more about semantics than investment strategy. He cited a dictionary definition of speculation:
Engagement in any business transaction involving considerable risk for the chance of large gains.
In contrast, the same dictionary defined investment as follows:
The investing of money or capital for profitable returns.
Frank pointed out the absence of the words risk, chance or large gains in the definition of investment. He wrote about this obvious bias: speculation = risky and investment = safe; a viewpoint with which he totally disagreed. He explained his position as follows:
Right off, let us agree to a stipulated definition that all so-called investing in common stocks is a form of speculation. I believe it is important at the outset, throughout the pages of this book, and indeed in our everyday thinking about the stock market, to be aware and admit that when we trade stocks or buy them for their long-term potential, we are speculators.
The point of this discussion is not to clarify the distinctions being drawn by these authors, but to suggest that you, as an individual investor, must ask yourself a question before you buy a security. Regardless of how you may define the words, are you thinking like an investor, a speculator or a gambler? In any event, whether you are looking for long term appreciation or quick profit, you should save the gambling for Las Vegas, not Wall Street.
The material from Al Frank's New Prudent Speculator by Al Frank, copyright 1995 by Al Frank, is used with permission of the copyright holders, the heirs of Al Frank.
As always, I welcome your comments.
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