Monday, June 25, 2012
Microscopes, Telescopes and Satellites (1)
WALL STREET SMARTS, THE BLOG, IS NOW WALL STREET SMARTS, THE BOOK. FULLY EDITED AND REVISED WITH NEW MATERIAL ON AMAZON
All three of the tools listed in the title are used to look at things, but each is used for a specific purpose. Microscopes enable us to focus on objects invisible to the naked eye. Telescopes enable us to view view things several miles away in sharp detail. Satellites orbiting hundreds of miles in the atmosphere provide us clear pictures of the earth's surface and weather patterns affecting it. Each instrument is used to view objects at different distances. Like most tools, if not used correctly, they are of little help. I would like to analogize them to tools used in the market for making investments. In my analogy, we are concerned with time, not distance. Once again, if not used correctly, problems can occur with market tools.
Bradbury K. Thurlow discussed investment time frames in his book, Rediscovering the Wheel: Contrary Thinking & Investment Strategy.
Technical analysis, like its grandparent the Dow Theory, rests on the assumption that stock prices move in well-defined trends, up or down, and that these are of three kinds, short, intermediate and long, according to how long they last and how far they carry. For historians, a fourth kind is labeled secular, running presumably back to the garden of Eden.*
(Author's emphasis in bold)
An individual relying on technical analysis looks at the detailed movement of a stock, much like a scientist might look through a microscope at a specimen slide. Based on hourly, daily or weekly price movement, the technical speculator or day trader plots a stock's future direction and invests based on that probable price movement. The day trader may not care what the stock did six months ago or what it might do six months from now. This type of speculator is only concerned with making a quick profit in the next few hours or days. But this can create a problem. As Al Frank pointed out in his book, Al Frank's New Prudent Speculator, the shorter the time period being examined, the more likely the movement will be random. Investing based on random movement is about as close to coin tossing as one can get.
Justin Mamis wrote about short term trading in his 1994 book, When to Sell -- Inside Strategies for Stock-Market Profits as follows:
Just as long-term investors pooh-pooh market swings as not affecting them, short term traders exaggerate the significance of every little twitch, convinced that looking at the market through a microscope will disclose its secrets. This need has been intensified by what seems, to such traders, to be the almost magical solution -- that is, computers. Nowadays, you can actually put those twitches up on the screen like a dentist scrutinizing an X-ray: this "molar" is healthy, but look, over here, three downticks in a row in your "lower left bicuspid." These tick by tick, or moment-to-moment charts have all the appearance of reality, and can, indeed, be "read" the same way as a daily or weekly chart...so the trader believes in them far beyond their usefulness. They cause over-trading, and all losses lead from that. They create a belief that one knows what one is doing, when it is really the noise of the trading floor and trading rooms around the country that one is staring at. (This criticism/warning is of course not only valid for charts of options, futures and stocks themselves but also for indicators, especially those oscillator types that ring "signal" bells all day long and then again overnight.)**
(Author's emphasis in bold)
We will continue looking at investing time frames in the next blog.
* Excerpt from Rediscovering the Wheel: Contrary Thinking & Investment Strategy, Bradbury K. Thurlow, copyright ©1981, published by Fraser Publishing Company, is used by permission of the current copyright holder.
**Excerpt from When To Sell - Inside Strategies for Stock-Market Profits, Justin Mamis, copyright ©1994, published by Fraser Publishing Company, is used by permission of the publisher and Mr. Mamis.
Comments are always welcome.
Monday, June 18, 2012
Do I Need A Haircut?
WALL STREET SMARTS, THE BLOG, IS NOW WALL STREET SMARTS, THE BOOK. FULLY EDITED AND REVISED WITH NEW MATERIAL ON AMAZON
The answer to the question raised in the title of this blog depends, to a certain extent, on the person you ask. If you ask a friend, your spouse or a stranger on the street, you can probably expect an unbiased answer. If you ask your barber or hair stylist, you know the answer will be a resounding "Yes, you need one." Now, let's rephrase the question. Ask your broker "What should I do with my money?" Odds are you will be told "You should invest it." You should expect this answer regardless of the state of the market or the economy.
The hair care and the broker professions are both honorable; however, their practitioners need to eat and pay the rent or mortgage, just like the rest of us. The individual investor should maintain some healthy skepticism when presented with investment opportunities by his or her investment professional. The broker is paid for facilitating investment purchases and sales, not giving advice. Indeed, the broker hopes that any advice given will lead to a transaction. Bradbury K. Thurlow pointed this out in his book, Rediscovering the Wheel: Contrary Thinking & Investment Strategy, as follows:
As a commission salesman he is not being paid to express his own opinions, but to create activity in your account, which places him in an instant and recurrent conflict of interests whenever his opinion is asked for. This does not mean that he may not have excellent opinions of his own or that his primary interest may not genuinely be your welfare -- it ought to be if the relationship is to be lasting.
The broker's services, as shown earlier, are to provide essential information (on demand), the convenience of safe keeping, and entertainment of various sorts, not the least important of which will be ego gratification. The broker is by definition the go-between in a two sided market. The amateur will be wise never to forget that someone of at least equal intelligence and knowledge may be on the other side of every transaction he makes.*
In his amusing book, Where Are the Customers' Yachts? or A Good Hard Look At Wall Street. Fred Schwed, Jr. recounted the following apocryphal story about an exchange between a broker and a customer in 1928:
There was at that time engaged in the bank stock business, along with an awful lot of others, a large red-necked Texan. He had brought to his profession a booming Texas voice and a calcified conscience. On this occasion he had just sold a customer twenty shares of Guarantee Trust Company stock at $760 a share at the moment when it could have been purchased anywhere else at $730. The customer, the big sorehead, had just found this out and had called back with a view toward remonstrance. The Texan cut him short. "Suh," he boomed, "you-all don't appreciate what the policy of this firm is. This-heah firm selects investments foh its clients not on a basis of Price, but of Value!"**
John Rothchild is a business writer who, in 1985, took a year off from his profession to learn everything he could about investments and Wall Street. He chronicled the year in his book, A Fool and His Money, The Odyssey of an Average Investor. He wrote about what it takes to become a stock broker. He learned that, at that time, it took approximately four months to become a licensed stock broker. A licensed beauty parlor operator received six months of training, and earning a plumber's license required two years of training. Obviously, food for thought. Rothchild attended some broker training sessions at major brokerage firms and learned that the majority of the training was devoted to sales techniques. He concluded his exposition of the classes with the following observation:
There were hour-long classes in various aspects of stocks and bonds that I would have mentioned earlier, except inserting them as an afterthought gives you a better idea of their relative importance as against, say, sales.***
It seems apparent to me that an individual who spends time researching investment opportunities and choosing the one which meets his or her requirements does not really need a stock broker. Purchases and sales can be made electronically through an on-line brokerage firm at a cost per transaction which is far less than that charged by the traditional brokerage house. Indeed, an individual investor with an investment strategy who is willing to devote the time to research his or her investment options may be better off without the aid or advice of a stock broker.
* Excerpts from Rediscovering the Wheel: Contrary Thinking & Investment Strategy, Bradbury K. Thurlow, copyright ©1981, published by Fraser Publishing Company, are used by permission of the current copyright holder.
** Excerpt from Where Are the Customer's Yachts? or A Good Hard Look At Wall Street, Fred Schwed, Jr., copyright © 1940, republished by John Wiley & Sons, Inc, pages 186-187.
*** Excerpt from A Fool and His Money, The Odyssey of an Average Investor, John Rothchild, copyright © 1988, 1997, published by John Wiley & Sons, Inc., page 153.
Comments are always welcome.
The answer to the question raised in the title of this blog depends, to a certain extent, on the person you ask. If you ask a friend, your spouse or a stranger on the street, you can probably expect an unbiased answer. If you ask your barber or hair stylist, you know the answer will be a resounding "Yes, you need one." Now, let's rephrase the question. Ask your broker "What should I do with my money?" Odds are you will be told "You should invest it." You should expect this answer regardless of the state of the market or the economy.
The hair care and the broker professions are both honorable; however, their practitioners need to eat and pay the rent or mortgage, just like the rest of us. The individual investor should maintain some healthy skepticism when presented with investment opportunities by his or her investment professional. The broker is paid for facilitating investment purchases and sales, not giving advice. Indeed, the broker hopes that any advice given will lead to a transaction. Bradbury K. Thurlow pointed this out in his book, Rediscovering the Wheel: Contrary Thinking & Investment Strategy, as follows:
As a commission salesman he is not being paid to express his own opinions, but to create activity in your account, which places him in an instant and recurrent conflict of interests whenever his opinion is asked for. This does not mean that he may not have excellent opinions of his own or that his primary interest may not genuinely be your welfare -- it ought to be if the relationship is to be lasting.
The broker's services, as shown earlier, are to provide essential information (on demand), the convenience of safe keeping, and entertainment of various sorts, not the least important of which will be ego gratification. The broker is by definition the go-between in a two sided market. The amateur will be wise never to forget that someone of at least equal intelligence and knowledge may be on the other side of every transaction he makes.*
In his amusing book, Where Are the Customers' Yachts? or A Good Hard Look At Wall Street. Fred Schwed, Jr. recounted the following apocryphal story about an exchange between a broker and a customer in 1928:
There was at that time engaged in the bank stock business, along with an awful lot of others, a large red-necked Texan. He had brought to his profession a booming Texas voice and a calcified conscience. On this occasion he had just sold a customer twenty shares of Guarantee Trust Company stock at $760 a share at the moment when it could have been purchased anywhere else at $730. The customer, the big sorehead, had just found this out and had called back with a view toward remonstrance. The Texan cut him short. "Suh," he boomed, "you-all don't appreciate what the policy of this firm is. This-heah firm selects investments foh its clients not on a basis of Price, but of Value!"**
John Rothchild is a business writer who, in 1985, took a year off from his profession to learn everything he could about investments and Wall Street. He chronicled the year in his book, A Fool and His Money, The Odyssey of an Average Investor. He wrote about what it takes to become a stock broker. He learned that, at that time, it took approximately four months to become a licensed stock broker. A licensed beauty parlor operator received six months of training, and earning a plumber's license required two years of training. Obviously, food for thought. Rothchild attended some broker training sessions at major brokerage firms and learned that the majority of the training was devoted to sales techniques. He concluded his exposition of the classes with the following observation:
There were hour-long classes in various aspects of stocks and bonds that I would have mentioned earlier, except inserting them as an afterthought gives you a better idea of their relative importance as against, say, sales.***
It seems apparent to me that an individual who spends time researching investment opportunities and choosing the one which meets his or her requirements does not really need a stock broker. Purchases and sales can be made electronically through an on-line brokerage firm at a cost per transaction which is far less than that charged by the traditional brokerage house. Indeed, an individual investor with an investment strategy who is willing to devote the time to research his or her investment options may be better off without the aid or advice of a stock broker.
* Excerpts from Rediscovering the Wheel: Contrary Thinking & Investment Strategy, Bradbury K. Thurlow, copyright ©1981, published by Fraser Publishing Company, are used by permission of the current copyright holder.
** Excerpt from Where Are the Customer's Yachts? or A Good Hard Look At Wall Street, Fred Schwed, Jr., copyright © 1940, republished by John Wiley & Sons, Inc, pages 186-187.
*** Excerpt from A Fool and His Money, The Odyssey of an Average Investor, John Rothchild, copyright © 1988, 1997, published by John Wiley & Sons, Inc., page 153.
Comments are always welcome.
Monday, June 11, 2012
If You're So Smart, Why Aren't You Rich? (2)
WALL STREET SMARTS, THE BLOG, IS NOW WALL STREET SMARTS, THE BOOK. FULLY EDITED AND REVISED WITH NEW MATERIAL ON AMAZON
In his book, Irrational Exuberance, Professor Robert J. Shiller wrote that there is little difference between professional and individual investors. His analysis was as follows:
Some observers believe that professional investment managers are more sensible and work to offset the irrational exuberance of the non-professional investing public. Therefore these observers might argue that a sharp distinction should be drawn between the behavior of the professionals and the nonprofessionals. Professional investors, however, are not immune from the effects of the popular investing culture that we observe in individual investors, and many of the factors described here no doubt influence their thinking as well. There is in fact no clear distinction between professional institutional investors and individual investors, since the professionals routinely give advice to the individual investors.*
(Author's emphasis in bold)
For the amateur, the most powerful emotions are fear and greed. Bradbury K. Thurlow discusses the psychological forces preying on the individual investor in his book, Rediscovering the Wheel: Contrary Thinking & Investment Strategy. He described their impact on an individual as follows:
Let us begin with the oldest psychological market cliche of them all: "Price movements are motivated by greed and fear." Greed and fear, as most of us understand them, are intensely personal emotions; as they occur in the stock market they are social emotions. The two are similar, but do not operate in precisely the same manner. In the individual, fear and greed are both derived from the basic instinct of self-preservation. Fear in our present context is exclusively related to the loss of financial security; greed is the emotional desire to increase the security base to infinity to protect against possible future loss.
Thurlow then went on to describe the equivalent emotions in the professional investor as follows:
An investment manager's closest approach to fear is the uncertainty over whether he will lose an account; if he works in a large institution even this emotion will be attenuated to a more or less vague anxiety that he or his organization will perform much worse than the competition. The structural defense against this anxiety is to imitate the competition. For this reason institutional conformity tends to increase as speculative confidence decreases. One of the most painful of all present-day situations is to be proven wrong and know you stand alone.
Conversely, as speculative confidence increases, conformity diminishes and decision makers are more willing to use their imagination. Speculative success leads to alternating periods of anxiety -- grab the profit before the price falls -- and emulation -- we can take business away from them if we just take a little more risk. In the extreme maturity of the bullish cycle many institutions will have quite shed their timidity and will be emulating their peers by investing in increasingly "far out" concepts.**
He agreed with Professor Shiller that emotions can affect everyone on Wall Street and concluded his comparison of the professional and the amateur with the following:
A contrarian reading of the contradictions between investment professionals and amateurs would disclose that the former are so called because they are paid to serve the interests of the latter.
Finally, the professional, as a fellow investor, will be competing for profits in the same market and will constantly be working, against the amateur and against other professionals, to pursue every advantage. This, contrarily, gives the amateur a reasonable chance of success, if he can only learn to avoid the psychological mistakes to which all of us are equally subject.**
The individual investor/speculator will usually have contact with only one type of market professional, the stock broker who takes buy and sell orders. We will look at brokers in the next blog.
* Excerpt from SHILLER, ROBERT J.; IRRATIONAL EXUBERANCE, copyright 2000 Robert J. Shiller, published by Princeton University Press, reprinted by permission of Princeton University Press.
** Excerpts from Rediscovering the Wheel: Contrary Thinking & Investment Strategy, Bradbury K. Thurlow, ©1981, published by Fraser Publishing Company, are used by permission of the current copyright holder.
Comments are always welcome.
In his book, Irrational Exuberance, Professor Robert J. Shiller wrote that there is little difference between professional and individual investors. His analysis was as follows:
Some observers believe that professional investment managers are more sensible and work to offset the irrational exuberance of the non-professional investing public. Therefore these observers might argue that a sharp distinction should be drawn between the behavior of the professionals and the nonprofessionals. Professional investors, however, are not immune from the effects of the popular investing culture that we observe in individual investors, and many of the factors described here no doubt influence their thinking as well. There is in fact no clear distinction between professional institutional investors and individual investors, since the professionals routinely give advice to the individual investors.*
(Author's emphasis in bold)
For the amateur, the most powerful emotions are fear and greed. Bradbury K. Thurlow discusses the psychological forces preying on the individual investor in his book, Rediscovering the Wheel: Contrary Thinking & Investment Strategy. He described their impact on an individual as follows:
Let us begin with the oldest psychological market cliche of them all: "Price movements are motivated by greed and fear." Greed and fear, as most of us understand them, are intensely personal emotions; as they occur in the stock market they are social emotions. The two are similar, but do not operate in precisely the same manner. In the individual, fear and greed are both derived from the basic instinct of self-preservation. Fear in our present context is exclusively related to the loss of financial security; greed is the emotional desire to increase the security base to infinity to protect against possible future loss.
Thurlow then went on to describe the equivalent emotions in the professional investor as follows:
An investment manager's closest approach to fear is the uncertainty over whether he will lose an account; if he works in a large institution even this emotion will be attenuated to a more or less vague anxiety that he or his organization will perform much worse than the competition. The structural defense against this anxiety is to imitate the competition. For this reason institutional conformity tends to increase as speculative confidence decreases. One of the most painful of all present-day situations is to be proven wrong and know you stand alone.
Conversely, as speculative confidence increases, conformity diminishes and decision makers are more willing to use their imagination. Speculative success leads to alternating periods of anxiety -- grab the profit before the price falls -- and emulation -- we can take business away from them if we just take a little more risk. In the extreme maturity of the bullish cycle many institutions will have quite shed their timidity and will be emulating their peers by investing in increasingly "far out" concepts.**
He agreed with Professor Shiller that emotions can affect everyone on Wall Street and concluded his comparison of the professional and the amateur with the following:
A contrarian reading of the contradictions between investment professionals and amateurs would disclose that the former are so called because they are paid to serve the interests of the latter.
Finally, the professional, as a fellow investor, will be competing for profits in the same market and will constantly be working, against the amateur and against other professionals, to pursue every advantage. This, contrarily, gives the amateur a reasonable chance of success, if he can only learn to avoid the psychological mistakes to which all of us are equally subject.**
The individual investor/speculator will usually have contact with only one type of market professional, the stock broker who takes buy and sell orders. We will look at brokers in the next blog.
* Excerpt from SHILLER, ROBERT J.; IRRATIONAL EXUBERANCE, copyright 2000 Robert J. Shiller, published by Princeton University Press, reprinted by permission of Princeton University Press.
** Excerpts from Rediscovering the Wheel: Contrary Thinking & Investment Strategy, Bradbury K. Thurlow, ©1981, published by Fraser Publishing Company, are used by permission of the current copyright holder.
Comments are always welcome.
Monday, June 4, 2012
If You're So Smart, Why Aren't You Rich? (1)
WALL STREET SMARTS, THE BLOG, IS NOW WALL STREET SMARTS, THE BOOK. FULLY EDITED AND REVISED WITH NEW MATERIAL ON AMAZON
Can the individual investor, with limited time and resources, hope to succeed in a market full of professional investors and money managers? Surprisingly, many financial writers answer this question affirmatively. Bradbury K. Thurlow wrote the following in the introduction to his 1981 classic, Rediscovering the Wheel: Contrary Thinking & Investment Strategy:
As long as the present institutional situation persists -- and it appears it can only intensify with the continuing mushrooming (cancerous) growth in pension funds -- the smaller professional investor will have a distinct competitive advantage over the larger professional. Whether the amateur investor can match the smaller professional is a question I had much in mind in writing this book and never satisfactorily answered. If the investor spends enough time on the subject, he becomes, paid or not, a professional and, to the extent he is handling his own money, he has the strongest of all motives to succeed. He is exempt from the professional's frequent requirement to provide irrelevant entertainment to clients by explaining transactions that may be based on intuition. On the whole, the amateur, if he is properly disciplined and does his homework, should do about as well as the small professional and much better than the large professional investor.*
We need to remember, as Humphrey B. Neill pointed out in Tape Reading & Market Tactics, that, regardless of age, gender, race, family background, level of education, degree of intellect or station in life, every participant in the market shares one universally common trait: everyone is human. Notwithstanding their financial education and market training, the professionals on Wall Street remain just as susceptible to human emotions and the contagion of the investment crowd as the first time investor.
In The Money Game, Adam Smith quoted John Maynard Keynes concerning the goals of Wall Street professionals as follows:
Mr. Smith concluded this excerpt from Keynes with the statement, "That is the way it is, and no one has ever said it better."**
It would appear that professionals focus and trade as speculators, not long term investors. If that is the case, then one might ask what the true goal of the professional investor really is. We will delve into this in greater depth in the next blog.
* Excerpt from Rediscovering the Wheel: Contrary Thinking & Investment Strategy, Bradbury K. Thurlow, copyright ©1981, published by Fraser Publishing Company, is used by permission of the current copyright holder.
** Excerpts from The Money Game by Adam Smith, copyright © 1967, 1968 by Adam Smith are used by permission of Random House, Inc.
Comments are always welcome.
Can the individual investor, with limited time and resources, hope to succeed in a market full of professional investors and money managers? Surprisingly, many financial writers answer this question affirmatively. Bradbury K. Thurlow wrote the following in the introduction to his 1981 classic, Rediscovering the Wheel: Contrary Thinking & Investment Strategy:
As long as the present institutional situation persists -- and it appears it can only intensify with the continuing mushrooming (cancerous) growth in pension funds -- the smaller professional investor will have a distinct competitive advantage over the larger professional. Whether the amateur investor can match the smaller professional is a question I had much in mind in writing this book and never satisfactorily answered. If the investor spends enough time on the subject, he becomes, paid or not, a professional and, to the extent he is handling his own money, he has the strongest of all motives to succeed. He is exempt from the professional's frequent requirement to provide irrelevant entertainment to clients by explaining transactions that may be based on intuition. On the whole, the amateur, if he is properly disciplined and does his homework, should do about as well as the small professional and much better than the large professional investor.*
We need to remember, as Humphrey B. Neill pointed out in Tape Reading & Market Tactics, that, regardless of age, gender, race, family background, level of education, degree of intellect or station in life, every participant in the market shares one universally common trait: everyone is human. Notwithstanding their financial education and market training, the professionals on Wall Street remain just as susceptible to human emotions and the contagion of the investment crowd as the first time investor.
In The Money Game, Adam Smith quoted John Maynard Keynes concerning the goals of Wall Street professionals as follows:
Our good Lord Keynes had it all spotted out in 1935, in one of the most acute passages ever written:
"It might have been supposed that competition between expert professionals, possessing judgment and knowledge beyond that of the average private investor, would correct the vagaries of the ignorant individual left to himself. It happens, however, that the energies and skill of the professional investor and speculator are mainly occupied otherwise. For most of these persons are, in fact, largely concerned, not with making superior long-term forecasts of the probable yield of an investment over its whole life, but with foreseeing changes in the conventional basis of valuation a short time ahead of the general public. They are concerned not with what an investment is really worth to a man who buys it "for keeps," but with what the market will value it at, under the influence of mass psychology, three months or a year hence.**
Mr. Smith concluded this excerpt from Keynes with the statement, "That is the way it is, and no one has ever said it better."**
It would appear that professionals focus and trade as speculators, not long term investors. If that is the case, then one might ask what the true goal of the professional investor really is. We will delve into this in greater depth in the next blog.
* Excerpt from Rediscovering the Wheel: Contrary Thinking & Investment Strategy, Bradbury K. Thurlow, copyright ©1981, published by Fraser Publishing Company, is used by permission of the current copyright holder.
** Excerpts from The Money Game by Adam Smith, copyright © 1967, 1968 by Adam Smith are used by permission of Random House, Inc.
Comments are always welcome.
Monday, May 28, 2012
Blind Men And The Elephant & World War II
WALL STREET SMARTS, THE BLOG, IS NOW WALL STREET SMARTS, THE BOOK. FULLY EDITED AND REVISED WITH NEW MATERIAL ON AMAZON
We began our studies of fundamental analysis, technical analysis and random walk theory over a year ago. We have learned about each investment strategy, its core beliefs and its suggested methods of profiting in the market. The proponents of each form of investing not only tout the merits of their preferred method, but also spend almost as much time and effort denigrating the others. I am reminded of the old parable about a group of blind men and an elephant which is found in Buddhist, Sufi Muslim, Hindu and other religious/philosophical writings.
Supposedly originating in India centuries ago, the many versions of the basic story focus on either a number of blind men or several men in a completely dark room. They are introduced to a king's elephant and given the task of describing it using only the sense of touch. The catch, of course, is that each individual can explore only one part of the animal and none of the men can touch the same part. In each version of the parable, the men report to the king the results of their explorations. The man who felt the leg describes the animal as a pillar; the man who grabbed the tail imagines the elephant as a rope; the one who explored the trunk reports that the elephant is like a large tree branch. Conflicting reports are also provided by the individuals who touched the stomach, an ear and a tusk. The men argue about who is correct. The king resolves the dispute by explaining that each of them is correct based on what they felt (their individual perspectives); however, none of them is totally correct.
Like the elephant and its many parts, the market has many different investments to offer to investors and speculators. The investors and speculators also differ in many ways, but are the same in certain respects; each one has a goal, a preferred method of achieving that goal and a time frame within which to do so. Depending on an investor's focus; how he or she chooses to invest, and the available time for investing, the individual may be correct, given the personal goal. However, individual success does not necessarily require the blanket exclusion of other investment options or techniques under all other circumstances.
For example, a young person who is putting aside money regularly for retirement will, in all probability, invest with long term capital appreciation in mind, seeking to increase the amount of his or her retirement funds over time. A person who is looking for a run of small profits may engage in what is called day trading where profits are measured in fractions of a dollar quickly gained. A person who is nearing retirement may reduce the number of more speculative stocks he or she owns and convert them to more conservative holdings. This person is giving up the chance for large gains in order to avoid untimely losses. Someone who has retired may be looking for a reliable income stream to support his or her desired lifestyle. A retiree may sell some stocks previously held for appreciation and invest the proceeds in stocks paying steady, safe dividends.
Given their divergent goals, does it make any sense for the young day trader to criticize the dividend strategy of the retiree? Should the technical analyst seeking to predict the projected movement of a stock over the next several months scoff at the multi-year strategy of the long term value investor?
Think of World War II as an analogy for the market. This global conflict was fought throughout Europe, Africa, Russia, the Far East and the Pacific Islands. The tactics and equipment used by the opponents were not the same in the Ardennes forests, the African deserts, the City of Stalingrad, the Burmese jungles or the islands dotting the Pacific. Each side and their armies had the same ultimate goal, victory. The strategies, tactics and maneuvers with which they went about it depended on who, where, when and how the opposing forces met in combat. In a similar fashion, investors come to the market with the same goal, profit. As with those armies, the investors' strategies, tactics and investing maneuvers will be based on how they see profits can be made in the time period they have available to them.
In the next blog we will look at the differences between individual investors, the so called amateurs, and Wall Street professionals.
Comments are always welcome.
We began our studies of fundamental analysis, technical analysis and random walk theory over a year ago. We have learned about each investment strategy, its core beliefs and its suggested methods of profiting in the market. The proponents of each form of investing not only tout the merits of their preferred method, but also spend almost as much time and effort denigrating the others. I am reminded of the old parable about a group of blind men and an elephant which is found in Buddhist, Sufi Muslim, Hindu and other religious/philosophical writings.
Supposedly originating in India centuries ago, the many versions of the basic story focus on either a number of blind men or several men in a completely dark room. They are introduced to a king's elephant and given the task of describing it using only the sense of touch. The catch, of course, is that each individual can explore only one part of the animal and none of the men can touch the same part. In each version of the parable, the men report to the king the results of their explorations. The man who felt the leg describes the animal as a pillar; the man who grabbed the tail imagines the elephant as a rope; the one who explored the trunk reports that the elephant is like a large tree branch. Conflicting reports are also provided by the individuals who touched the stomach, an ear and a tusk. The men argue about who is correct. The king resolves the dispute by explaining that each of them is correct based on what they felt (their individual perspectives); however, none of them is totally correct.
Like the elephant and its many parts, the market has many different investments to offer to investors and speculators. The investors and speculators also differ in many ways, but are the same in certain respects; each one has a goal, a preferred method of achieving that goal and a time frame within which to do so. Depending on an investor's focus; how he or she chooses to invest, and the available time for investing, the individual may be correct, given the personal goal. However, individual success does not necessarily require the blanket exclusion of other investment options or techniques under all other circumstances.
For example, a young person who is putting aside money regularly for retirement will, in all probability, invest with long term capital appreciation in mind, seeking to increase the amount of his or her retirement funds over time. A person who is looking for a run of small profits may engage in what is called day trading where profits are measured in fractions of a dollar quickly gained. A person who is nearing retirement may reduce the number of more speculative stocks he or she owns and convert them to more conservative holdings. This person is giving up the chance for large gains in order to avoid untimely losses. Someone who has retired may be looking for a reliable income stream to support his or her desired lifestyle. A retiree may sell some stocks previously held for appreciation and invest the proceeds in stocks paying steady, safe dividends.
Given their divergent goals, does it make any sense for the young day trader to criticize the dividend strategy of the retiree? Should the technical analyst seeking to predict the projected movement of a stock over the next several months scoff at the multi-year strategy of the long term value investor?
Think of World War II as an analogy for the market. This global conflict was fought throughout Europe, Africa, Russia, the Far East and the Pacific Islands. The tactics and equipment used by the opponents were not the same in the Ardennes forests, the African deserts, the City of Stalingrad, the Burmese jungles or the islands dotting the Pacific. Each side and their armies had the same ultimate goal, victory. The strategies, tactics and maneuvers with which they went about it depended on who, where, when and how the opposing forces met in combat. In a similar fashion, investors come to the market with the same goal, profit. As with those armies, the investors' strategies, tactics and investing maneuvers will be based on how they see profits can be made in the time period they have available to them.
In the next blog we will look at the differences between individual investors, the so called amateurs, and Wall Street professionals.
Comments are always welcome.
Monday, May 21, 2012
Some Final Random Thoughts (5)
WALL STREET SMARTS, THE BLOG, IS NOW WALL STREET SMARTS, THE BOOK. FULLY EDITED AND REVISED WITH NEW MATERIAL ON AMAZON
Many years ago, my three children were watching television shortly after we had signed up for cable service. One of the kids' channels back then was Nickelodeon. I remember all three of them rushing up to me yelling that the TV was broken. When I asked them what was wrong, they breathlessly reported that, most importantly, they hadn't done anything to the TV set or the remote control and that there was no color on the picture. Not necessarily buying their story that they had done nothing wrong, I went to investigate. I started laughing when I realized that the program they were watching was an old show from the 1950s. Their jaws dropped when I informed them that the show was one I had watched when I was a child, and that there were no television shows in color at that time. They were so shocked at this news that, at first, I don't think they really believed me. We had to alternate between several channels, flipping back and forth between color programming and the old black and white broadcast before they accepted the idea.
I assume older investors (I count myself as one of them) can remember the days before index funds, but younger investors might be surprised to learn that one of the most popular types of mutual funds today, the S&P 500 index fund, is not yet 40 years old. Our old friend Adam Smith wrote several books in addition to his classic, The Money Game. One of them, Super-Money, was published in 1972. In that book, he chronicled several studies at the time which concluded that market averages such as the S&P 500 beat the performance of most professionally managed mutual funds a majority of the time. The question was how to obtain these results without having to buy all 500 stocks. Mr. Smith wrote the following:
Of course, you cannot buy a statistically random portfolio, even though your portfolio may have a very random look about it. And you cannot really buy the Dow Jones average or the Standard & Poor. If you are going to buy a fund -- or the equivalent slice in a bank-managed common trust -- you have to buy that, and you hope that your fund or your banker is at the top of the list, helping the team against the randoms, and not at the bottom.*
About the same time, Professor Burton Malkiel wrote his first of ultimately ten editions of A Random Walk Down Wall Street and joined Adam Smith's lament as follows:
What we need is a no-load, minimum management-fee mutual fund that simply buys the hundreds of stocks making up the broad stock-market averages and does no trading from security to security in an attempt to catch the winners. Whenever below-average performance on the part of a mutual fund is noticed, fund salesmen are quick to point out "You can't buy the averages." It's time the public could.**
An S&P 500 index fund buys the stocks that make up the index in the same percentages as exist in the index. If, say, IBM represents 5% of the index, then it will be 5% of the fund's stock holdings. The value of the fund moves in lock step with the index itself, and the stocks held in the fund are changed only when a company is removed from the index and a new company replaces it.
Two banks, Wells Fargo and American National Bank in Chicago, offered such index funds to their institutional clients in 1973. John Bogle, the founder of investment giant Vanguard Group, was the first to offer an index fund holding the S&P 500 stocks to the investing public in 1975. When it started, the index fund attracted $11 million, which was then, and still is, considered a pittance. Twenty-four years later, 1999, that index fund had grown to $50 billion. Combined, Vanguard's family of funds totaled $100 billion that year. Investors who did not want to pick individual stocks for their portfolio understood that they could inexpensively harness the random movements of the stock market and match its annual averages. They flocked to the fund. Today most investment companies include an S&P 500 Index fund in their investment offerings.
Like many investment strategies before it, the Random Walk theory has faded in popularity in recent years. However, the investment product it generated, the index fund, is alive and well on Wall Street.
* Excerpt from Super-Money by Adam Smith, copyright 1972, published by Fawcett Popular Library, page 95.
** Excerpt from A Random Walk Down Wall Street, by Burton Malkiel, copyright 1972, published by W.W. Norton, pages 226-227.
Comments are always welcome.
Many years ago, my three children were watching television shortly after we had signed up for cable service. One of the kids' channels back then was Nickelodeon. I remember all three of them rushing up to me yelling that the TV was broken. When I asked them what was wrong, they breathlessly reported that, most importantly, they hadn't done anything to the TV set or the remote control and that there was no color on the picture. Not necessarily buying their story that they had done nothing wrong, I went to investigate. I started laughing when I realized that the program they were watching was an old show from the 1950s. Their jaws dropped when I informed them that the show was one I had watched when I was a child, and that there were no television shows in color at that time. They were so shocked at this news that, at first, I don't think they really believed me. We had to alternate between several channels, flipping back and forth between color programming and the old black and white broadcast before they accepted the idea.
I assume older investors (I count myself as one of them) can remember the days before index funds, but younger investors might be surprised to learn that one of the most popular types of mutual funds today, the S&P 500 index fund, is not yet 40 years old. Our old friend Adam Smith wrote several books in addition to his classic, The Money Game. One of them, Super-Money, was published in 1972. In that book, he chronicled several studies at the time which concluded that market averages such as the S&P 500 beat the performance of most professionally managed mutual funds a majority of the time. The question was how to obtain these results without having to buy all 500 stocks. Mr. Smith wrote the following:
Of course, you cannot buy a statistically random portfolio, even though your portfolio may have a very random look about it. And you cannot really buy the Dow Jones average or the Standard & Poor. If you are going to buy a fund -- or the equivalent slice in a bank-managed common trust -- you have to buy that, and you hope that your fund or your banker is at the top of the list, helping the team against the randoms, and not at the bottom.*
About the same time, Professor Burton Malkiel wrote his first of ultimately ten editions of A Random Walk Down Wall Street and joined Adam Smith's lament as follows:
What we need is a no-load, minimum management-fee mutual fund that simply buys the hundreds of stocks making up the broad stock-market averages and does no trading from security to security in an attempt to catch the winners. Whenever below-average performance on the part of a mutual fund is noticed, fund salesmen are quick to point out "You can't buy the averages." It's time the public could.**
An S&P 500 index fund buys the stocks that make up the index in the same percentages as exist in the index. If, say, IBM represents 5% of the index, then it will be 5% of the fund's stock holdings. The value of the fund moves in lock step with the index itself, and the stocks held in the fund are changed only when a company is removed from the index and a new company replaces it.
Two banks, Wells Fargo and American National Bank in Chicago, offered such index funds to their institutional clients in 1973. John Bogle, the founder of investment giant Vanguard Group, was the first to offer an index fund holding the S&P 500 stocks to the investing public in 1975. When it started, the index fund attracted $11 million, which was then, and still is, considered a pittance. Twenty-four years later, 1999, that index fund had grown to $50 billion. Combined, Vanguard's family of funds totaled $100 billion that year. Investors who did not want to pick individual stocks for their portfolio understood that they could inexpensively harness the random movements of the stock market and match its annual averages. They flocked to the fund. Today most investment companies include an S&P 500 Index fund in their investment offerings.
Like many investment strategies before it, the Random Walk theory has faded in popularity in recent years. However, the investment product it generated, the index fund, is alive and well on Wall Street.
* Excerpt from Super-Money by Adam Smith, copyright 1972, published by Fawcett Popular Library, page 95.
** Excerpt from A Random Walk Down Wall Street, by Burton Malkiel, copyright 1972, published by W.W. Norton, pages 226-227.
Comments are always welcome.
Monday, May 14, 2012
More Random Thoughts (4)
WALL STREET SMARTS, THE BLOG, IS NOW WALL STREET SMARTS, THE BOOK. FULLY EDITED AND REVISED WITH NEW MATERIAL ON AMAZON
One of the main tenets of the Efficient Market Hypothesis (Random Walk) is the assumed rationality of an investor in the market. Economists refer to this creature as the "utility-maximizing agent." I'm not sure I really understand it, but I think what they mean is that people will always act in an economically reasonable manner in light of the circumstances they face. Many who criticize the academics for their Random Walk theory point to the people in Holland in the 1600s who were caught up in what is popularly called the tulip bulb craze. We read Charles Mackay's 1841 description of this investment boom/bubble in an earlier blog.
Professor Robert J. Shiller, a Yale economics professor and author, discussed the tulip bubble in his 2000 book, Irrational Exuberance, and argued that it was not necessarily an example of irrational behavior as follows:
But Mackay offered no concrete evidence that people were behaving insensibly and moreover could not show that the rage had anything to do with any speculative mispricing. Garber (Peter Garber is an economics researcher and author) points out that the really high prices were for rare varieties of tulips that had unusual patterns of coloration due, we now know, to infection by a mosaic virus. These tulips could not be readily propagated and were genuinely rare. People in Holland at the time highly valued these unusual tulips, which had great significance in their culture. Thus there is nothing more foolish about their high tulip prices than about the high prices that rare art objects or other collectibles often fetch today. Moreover, the price behavior of the tulip bulbs looks rather like that of the prices of many other speculative assets; they did not boom once, crash once, and then stay down as some simpler stories suggest. Prices of tulips went up and down numerous times, just as stock prices do all the time. These price changes could well have had some rational basis in new information about public demand for rare flowers becoming known to investors over time.*
In 1940 author Fred Schwed, Jr. wrote a hilarious account of Wall Street titled, Where Are the Customer's Yachts? or A Good Hard Look At Wall Street. It is said that he worked on Wall Street for only a couple of years in the 1920s, but he apparently figured out its foibles and eccentricities in that short time. As Schwed saw it, there were not that many "utility maximizing agents" on the Street when he was there. He summarized Wall Street's appetite for market booms as follows:
In attempting to find out just what, if anything, was good in the good old days it is necessary to determine when the good old days were. In some simple, but not straightforward, Wall Street minds, they were any days that preceded the Securities and Exchange Commission, when there weren't no ten commandments and a man could raise a thirst. Oh for the days when the most important rules were "Don't rebate on commissions," "Don't shoot the specialists," and "Don't smoke opium on the floor during trading hours."
It would be more correct and more honest to recognize that the good old days were simply boom days, like the booms of the late twenties, the late teens and the late nineteenth century.
In our moments of sober thought we all realize that booms are bad things, not good. But nearly all of us have a secret hankering for another one. "Another little orgy wouldn't do us any harm," is the feeling that persists both downtown and up. This is quite human, because in the last boom we acted so silly. If we are old enough we probably acted silly in the last three. We either got in too late, or out too late, or both. But now that we are experienced, just give us one more shot at a good reliable runaway boom!**
It seems to me that the answer to whether the market is rational/efficient or irrational/inefficient may be based simply on your personal beliefs about the subject. Ample evidence would appear to be available to buttress either position.
We will conclude our look at Random Walk in the next blog.
* Excerpt from SHILLER, ROBERT J.; IRRATIONAL EXUBERANCE, copyright 2000 Robert J. Shiller, published by Princeton University Press, reprinted by permission of Princeton University Press.
** Excerpts from Where Are the Customer's Yachts? or A Good Hard Look At Wall Street, Fred Schwed, Jr., copyright 1940, republished by John Wiley & Sons, Inc, pages 148-149.
Comments are always welcome.
One of the main tenets of the Efficient Market Hypothesis (Random Walk) is the assumed rationality of an investor in the market. Economists refer to this creature as the "utility-maximizing agent." I'm not sure I really understand it, but I think what they mean is that people will always act in an economically reasonable manner in light of the circumstances they face. Many who criticize the academics for their Random Walk theory point to the people in Holland in the 1600s who were caught up in what is popularly called the tulip bulb craze. We read Charles Mackay's 1841 description of this investment boom/bubble in an earlier blog.
Professor Robert J. Shiller, a Yale economics professor and author, discussed the tulip bubble in his 2000 book, Irrational Exuberance, and argued that it was not necessarily an example of irrational behavior as follows:
But Mackay offered no concrete evidence that people were behaving insensibly and moreover could not show that the rage had anything to do with any speculative mispricing. Garber (Peter Garber is an economics researcher and author) points out that the really high prices were for rare varieties of tulips that had unusual patterns of coloration due, we now know, to infection by a mosaic virus. These tulips could not be readily propagated and were genuinely rare. People in Holland at the time highly valued these unusual tulips, which had great significance in their culture. Thus there is nothing more foolish about their high tulip prices than about the high prices that rare art objects or other collectibles often fetch today. Moreover, the price behavior of the tulip bulbs looks rather like that of the prices of many other speculative assets; they did not boom once, crash once, and then stay down as some simpler stories suggest. Prices of tulips went up and down numerous times, just as stock prices do all the time. These price changes could well have had some rational basis in new information about public demand for rare flowers becoming known to investors over time.*
In 1940 author Fred Schwed, Jr. wrote a hilarious account of Wall Street titled, Where Are the Customer's Yachts? or A Good Hard Look At Wall Street. It is said that he worked on Wall Street for only a couple of years in the 1920s, but he apparently figured out its foibles and eccentricities in that short time. As Schwed saw it, there were not that many "utility maximizing agents" on the Street when he was there. He summarized Wall Street's appetite for market booms as follows:
In attempting to find out just what, if anything, was good in the good old days it is necessary to determine when the good old days were. In some simple, but not straightforward, Wall Street minds, they were any days that preceded the Securities and Exchange Commission, when there weren't no ten commandments and a man could raise a thirst. Oh for the days when the most important rules were "Don't rebate on commissions," "Don't shoot the specialists," and "Don't smoke opium on the floor during trading hours."
It would be more correct and more honest to recognize that the good old days were simply boom days, like the booms of the late twenties, the late teens and the late nineteenth century.
In our moments of sober thought we all realize that booms are bad things, not good. But nearly all of us have a secret hankering for another one. "Another little orgy wouldn't do us any harm," is the feeling that persists both downtown and up. This is quite human, because in the last boom we acted so silly. If we are old enough we probably acted silly in the last three. We either got in too late, or out too late, or both. But now that we are experienced, just give us one more shot at a good reliable runaway boom!**
It seems to me that the answer to whether the market is rational/efficient or irrational/inefficient may be based simply on your personal beliefs about the subject. Ample evidence would appear to be available to buttress either position.
We will conclude our look at Random Walk in the next blog.
* Excerpt from SHILLER, ROBERT J.; IRRATIONAL EXUBERANCE, copyright 2000 Robert J. Shiller, published by Princeton University Press, reprinted by permission of Princeton University Press.
** Excerpts from Where Are the Customer's Yachts? or A Good Hard Look At Wall Street, Fred Schwed, Jr., copyright 1940, republished by John Wiley & Sons, Inc, pages 148-149.
Comments are always welcome.
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