Stocks and Trading Thread - Channeling your inner Mono

[DGuller]

No, it isn't.  Based on the current understanding pf physics, a machine that puts out more energy than it takes in cannot exist.  If such a machine could and did exist, then it would be possible but not necessarily practical to create a perpetual motion machine.

Obviously I was a little ironic.  Figuring out ahead of time which investments will outperform the market in the future is only the most difficult, and some say impossible, part.

The existence of an investment in the past capable of consistently beating market averages, combined with the nature of how market averages are constructed, means that such investments will exist in the future. 

Of course.  I can guarantee you that 100% of the investments today will either outperform or underperform the market during the next 10 years.  None of them can match the market perfectly.  They can't all underperform, so at least one is bound to outperform.

The existence of such an investment that is itself composed primarily of investments also proves it is not impossible to find these in the future, as someone has done so in the past.  Thus, it is not impossible to beat the market or expect to beat the market.

I don't think you understand what "expect" means.  I can get 30 heads in the next 50 coin flips.  I cannot expect to get anything other than 25 heads in the next 50 coin flips.

[Baron von Schtinkenbutt]

The existence of such an investment that is itself composed primarily of investments also proves it is not impossible to find these in the future, as someone has done so in the past.  Thus, it is not impossible to beat the market or expect to beat the market.

I don't think you understand what "expect" means.  I can get 30 heads in the next 50 coin flips.  I cannot expect to get anything other than 25 heads in the next 50 coin flips.

Yes, but an ideal coin flip is a purely random process.  Were I to randomly construct a portfolio, I would agree.  However, saying the expected return of a portfolio is not significantly different from that of an index is saying that there exists no method to choose positions that is known to be better than random selection.

[Admiral Yi]

Yes, but an ideal coin flip is a purely random process.  Were I to randomly construct a portfolio, I would agree.  However, saying the expected return of a portfolio is not significantly different from that of an index is saying that there exists no method to choose positions that is known to be better than random selection.

Were there some method to consistently beat the market, everyone would do it, and you couldn't beat the market by doing it any more.

I'm very surprised by the BH share price.  I peeked at it not that long ago and I think it was trading at 16K.

[frunk]

Consistently beating the market shouldn't be significantly more difficult then accurately predicting the temperature and barometer readings at a location a month in advance.

[DGuller]

The existence of such an investment that is itself composed primarily of investments also proves it is not impossible to find these in the future, as someone has done so in the past.  Thus, it is not impossible to beat the market or expect to beat the market.

I don't think you understand what "expect" means.  I can get 30 heads in the next 50 coin flips.  I cannot expect to get anything other than 25 heads in the next 50 coin flips.

Yes, but an ideal coin flip is a purely random process.  Were I to randomly construct a portfolio, I would agree.  However, saying the expected return of a portfolio is not significantly different from that of an index is saying that there exists no method to choose positions that is known to be better than random selection.

The efficient market hypothesis states that all information is incorporated in the price, so any deviation from the market performance is indeed a purely random process.  Yes, some portfolios are going to get better returns, and some will get worse returns, but you can't predict which of them will do it ahead of time.  To get better expected returns than the market, you have to expose yourself to more systemic risk than the market.

[alfred russel]

Yes, but an ideal coin flip is a purely random process.  Were I to randomly construct a portfolio, I would agree.  However, saying the expected return of a portfolio is not significantly different from that of an index is saying that there exists no method to choose positions that is known to be better than random selection.

Were there some method to consistently beat the market, everyone would do it, and you couldn't beat the market by doing it any more.

I'm very surprised by the BH share price.  I peeked at it not that long ago and I think it was trading at 16K.

You were probably looking at a different class of stock than the one in the link.

[DGuller]

Yes, but an ideal coin flip is a purely random process.  Were I to randomly construct a portfolio, I would agree.  However, saying the expected return of a portfolio is not significantly different from that of an index is saying that there exists no method to choose positions that is known to be better than random selection.

Were there some method to consistently beat the market, everyone would do it, and you couldn't beat the market by doing it any more.

I'm very surprised by the BH share price.  I peeked at it not that long ago and I think it was trading at 16K.

You were probably looking at a different class of stock than the one in the link.

When you're as old as Yi, 1993 seems like yesterday.

[Caliga]

Sold Kinder Morgan for a significant gain last week.   I could have made more had my sell limit order not kicked off at my set price, but I'm still happy.

[The Minsky Moment]

However, saying the expected return of a portfolio is not significantly different from that of an index is saying that there exists no method to choose positions that is known to be better than random selection.

There are two that have been empirically demonstrated to work - one is the small stock premium and I forgot the second one.  I wouldn't bet on either continuing in the future in the long run but an asset allocation plan for the long haul that overweight small stocks a bit wouldn't be irrational.

That's basically it.  There have been many studies of the active side of the mutual fund industry and the findings are pretty consistent - the managers don't perform better than the index in aggregate, and past performance is no guide to future result so there is no way to pick the "good" funds in advance.

The hedge fund studies are a bit more mixed - some have results showing a small but identifiable outperformance.  However, the investor does not benefit because the premium is completely swallowed up (and then some) by fees.  Also one should be careful with these findings as correcting for survivorship bias is tricky.

As to why the hedgies might be able to slightly beat market, I have the following theories:
1). There is just enough dumb sucker money in the market to be taken advantage of to eke out a few dozen extra basis points.
2) A few players may take advantage of insider trading and help boost the averages. 
3). A few quant based funds may for at least a period of time succeed in exploiting tiny arbitrage opportunities
4). The rare genius.  Maybe Soros.  Maybe Buffet (although he doesn't use the fund structure).  If these rare birds truly exist beyond statistical artifact they are rare indeed.

None of this is of any relevance to the ordinary retail investor.   Allocating to indices is the only smart play at that level.  If you enjoy the game of picking stocks, go ahead - it is better than going to Vegas or the track.   If the only interest is portfolio maximization though, then you are just sucker money.

[alfred russel]

There are times with smaller cap stocks that I am convinced the market isn't efficient.

For example, one of my clients back when I was in public accounting had two different classes of stock--that only differed based on voting rights. A majority of the voting shares was held by a single entity, so voting rights really meant nothing. Historically the two classes traded very close together.

However, for a brief time, the shares widely diverged--the voting shares became worth more than twice the nonvoting. I'm not sure why--though there was an article written about the company as a great buy on something like Motley Fool that only mentioned the voting shares. I had left public accounting by that point, and so was free to trade their stock, and shorted the voting shares while buying the non voting. When share prices normalized, I made a decent profit, though I doubt any institutional investor would have cared--the company was too small to really make a huge profit.

There have been a few other similar circumstances (though less obvious) where I think that the market was missing something on very small companies.

[The Minsky Moment]

AR - as I mentioned in the post above, small stock performance is one of the only consistent anomalies that studies over the years have revealed.  So you may be on to something, but it is very much the exception not the rule.

What these means for the retail investor?  Unless you are going to put lots of hours obsessively analyzing small cap stocks, nothing other than maybe allocating a few extra percent to small cap.

[Admiral Yi]

If you enjoy the game of picking stocks, go ahead - it is better than going to Vegas or the track.   If the only interest is portfolio maximization though, then you are just sucker money.

I don't see why. 

[The Minsky Moment]

Which sentence is bothering you?

[Admiral Yi]

"You are just sucker money."

[The Minsky Moment]

"You are just sucker money."

OK.
If you are picking stocks actively, what you are doing is betting that the market price is lower than the true value.  Which means you think your own judgment about the stock is better than the considered judgment of other market participants.

What that means practically is that you are betting that you know better than:
1) The active managers - reasonably smart or sometimes really smart people who spend their professional lives analyzing stocks,
2) Quant types that deploy PhD math geniuses, supercomputers and proprietary algorithms to ferret out opportunities, and
3) Traders with inside information that you don't have.

That seems to me a bad bet - it's the old adage about what is going on if you can't spot the sucker at the card table - it's probably you.