Recently, I read a very interesting book about probabilities (actually quite a comprehensive treatise on probabilistic applications on the real world), and how it applies to our lives, and in the financial market (particularly so). This book is by Nicholas Nassem Taleb.
The interesting point is that, the author goes about illustrating how not only the common people, but specialists and professionals in their jobs would go about making absurd claims which are counter to what statistics and probability could tell us. I suppose this book would be more understandable and readable to the person more in tune with mathematics and computer programming, as most concepts are gathered from here.
However, simple examples are often used to highlight how people make fools of themselves. The author mentions that, journalists are actually entertainers, paid to entertain us with daily doses of insignificant events (or what a signal engineer would consider noise).
One important concept to illustrate of how he thinks traders are foolish. He claims that people are more prone to enjoy making small profits, daily, than to look at the expected profits in the longer term. Traders, or people who buy and sell securities and options, tend to be not open to the idea of losing small but making big. Instead, they multiply the small amount of profit to be made by making big bets. These are what lead to blow ups, situations where people make huge losses which they can no longer tolerate, emotionally and monetarily. It is a given that there are black swan events in the real world, especially so in the financial markets.
What are black swans? Consider this claim, "All swans are white" made by a person after observing say maybe all the different lakes available in the US. Can this claim be 100% true? It definitely cannot be, as what he has not observed does not give a confirmation that the un-observed event or thing is not present. It takes only 1 black swan to negate the claim.
Similarly, people in the financial markets tend to make absurd forecasts on the market based on past data. Can we say that we know everything about the market just by looking at (the maximum) all the historically available data and derive a causality to pinpoint the market direction tomorrow? Furthermore, the author also claims, most of the time, so called financial analysts or economists tend to retrofit explanations unto past data. Well, this is a very serious flaw, as it means anyone can come up with anything that sounds reasonable to the 'conventional thinking' to explain past data. Journalists in particular, who are not trained in these specific fields (like finance, mathematics, medicine, engineering), tend to oversimplify and over assume numbers and results.
Back to the main concept, so the author believes that since there are black swan events in the market (2 examples are the 1997 crisis, and the 9/11 attack), events that cannot be predicted, yet lead to severe market downfall, we should not overestimate our knowledge of the market. And his strategy is to profit from these events.
Sunday, February 03, 2008
Saturday, August 04, 2007
Strategies of Investing...not
I have always liked to think that I understood how the stock market works. I mean, it's not like I only started reading about the equities market and finance related news recently. I have had this interest since watching my dad following the prices daily on the teletext when I was 9. On days that the stocks he invested in went up in price, he rejoices. When prices came down, somehow his mood for the day changed. Of course this is understandable. Nobody wants to lose money. Back then I didn't understand the meaning of long term and short term investing.
Of course, many things happened since, and I would think that I have matured much more when it comes to understanding the market. As an observer, you watch how the market goes through cycles of ups and downs. You get all excited when the business report section of the news comes up on TV. They even have interesting financial jargons to give a human face to the market. When the market rises and there seems to be nothing that can stop its upward stride, it is called a bull. When the market free falls like in a bungee jump, it is called a bear. Interesting eh? How come a bull is associated with "upwards, forward, higher" but bear is associated with "falling, down, lower"? Don't people know that a bear is one of the most agile animals man has ever faced, and can outrun most animals? Maybe it's the association to a big, cuddly teddy bear. You know, the one with that big fat tummy and fat cheeks that make you smile and want to hug it.
There are many investing strategies that one can read from books, and other resources. The ultimate investor of it all (God of Investing, as how Chinese would put it) is none other than Mr Warren Buffet. Simply put, he prefers a strategy of not diversification, but choosing carefully for that company which he believes has great earning potential, and better than good management team, and to focus his investments on a small pool of such companies. This is of course against the notion of diversifying to minimize your exposure to risk. But he thinks that only fools diversify because you could not fully understand how a company works.
I think that, of course, this strategy sounds simple, and with homework done, you could very well make a nice profit. But for a beginner investor, an amateur like myself, I would say that you need balls of steel to invest like Buffet. And loads of money to back you up too, in case you fail. Let me futher explain why...
You see, it is easy to comprehend what you read in most investing strategies book, that one should buy low and sell high. Who the heck doesn't comprehend that? But when you are IN the market, when you have a significant sum of money in the market, your emotions would naturally be influenced by market movements. When you see your paper profit goes up in a stock, you keep hoping to see it go that 1 cent higher, and then the next... and then the next... I guess that's human greed.
On the other hand, when market trend reverses, and suppose the market drops rapidly (and i mean rapid with acceleration greater than 9.8m/s that it makes you feel like your balls are hanging in the air), the investment tip is to stay calm. Analyse what causes the market to fall. I suppose people who have been through many cyclical ups and downs in the stock market can and will tell you that the market needs a major correction once in awhile. But trust me, it is not easy to stay calm. You are faced with a dilemma, should you wait to see if stock prices rebound? But what if it continues with the massive drop? Then you start to think back, relax, if you're investing for the long term, then don't be disturbed by short term fluctuations. However, you're also concerned, what if the prices stay low for many years? Like what happened since 1997 till 2003.
The thing about stock market is that, even though finance and numbers are very technical, the core of the market is about humans. Humans are the ones agreeing on the buy and sell price, not the stocks themselves. You may wonder sometimes, why is there a need for a correction? Why can't stock just keep going higher and higher? It seems like people feel better if they associate the higher price with the assets and earnings of a company. And of course with good news. When stock analysts keep predicting that there will be doom and gloom when the market keeps going up, eventually it becomes a self-fulfilling prophecy.
So my conclusion is, i need to understand human behaviour and thinking more to better see why the market reacts in a certain way. Maybe it won't help in investing for the long run, but it helps to rationalize the market.
Of course, many things happened since, and I would think that I have matured much more when it comes to understanding the market. As an observer, you watch how the market goes through cycles of ups and downs. You get all excited when the business report section of the news comes up on TV. They even have interesting financial jargons to give a human face to the market. When the market rises and there seems to be nothing that can stop its upward stride, it is called a bull. When the market free falls like in a bungee jump, it is called a bear. Interesting eh? How come a bull is associated with "upwards, forward, higher" but bear is associated with "falling, down, lower"? Don't people know that a bear is one of the most agile animals man has ever faced, and can outrun most animals? Maybe it's the association to a big, cuddly teddy bear. You know, the one with that big fat tummy and fat cheeks that make you smile and want to hug it.
There are many investing strategies that one can read from books, and other resources. The ultimate investor of it all (God of Investing, as how Chinese would put it) is none other than Mr Warren Buffet. Simply put, he prefers a strategy of not diversification, but choosing carefully for that company which he believes has great earning potential, and better than good management team, and to focus his investments on a small pool of such companies. This is of course against the notion of diversifying to minimize your exposure to risk. But he thinks that only fools diversify because you could not fully understand how a company works.
I think that, of course, this strategy sounds simple, and with homework done, you could very well make a nice profit. But for a beginner investor, an amateur like myself, I would say that you need balls of steel to invest like Buffet. And loads of money to back you up too, in case you fail. Let me futher explain why...
You see, it is easy to comprehend what you read in most investing strategies book, that one should buy low and sell high. Who the heck doesn't comprehend that? But when you are IN the market, when you have a significant sum of money in the market, your emotions would naturally be influenced by market movements. When you see your paper profit goes up in a stock, you keep hoping to see it go that 1 cent higher, and then the next... and then the next... I guess that's human greed.
On the other hand, when market trend reverses, and suppose the market drops rapidly (and i mean rapid with acceleration greater than 9.8m/s that it makes you feel like your balls are hanging in the air), the investment tip is to stay calm. Analyse what causes the market to fall. I suppose people who have been through many cyclical ups and downs in the stock market can and will tell you that the market needs a major correction once in awhile. But trust me, it is not easy to stay calm. You are faced with a dilemma, should you wait to see if stock prices rebound? But what if it continues with the massive drop? Then you start to think back, relax, if you're investing for the long term, then don't be disturbed by short term fluctuations. However, you're also concerned, what if the prices stay low for many years? Like what happened since 1997 till 2003.
The thing about stock market is that, even though finance and numbers are very technical, the core of the market is about humans. Humans are the ones agreeing on the buy and sell price, not the stocks themselves. You may wonder sometimes, why is there a need for a correction? Why can't stock just keep going higher and higher? It seems like people feel better if they associate the higher price with the assets and earnings of a company. And of course with good news. When stock analysts keep predicting that there will be doom and gloom when the market keeps going up, eventually it becomes a self-fulfilling prophecy.
So my conclusion is, i need to understand human behaviour and thinking more to better see why the market reacts in a certain way. Maybe it won't help in investing for the long run, but it helps to rationalize the market.
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