Why you are likely to lose money if you follow some market analysts!

There are legions of websites, blogs, newsletters and firms peddling advice on how to trade or invest better in the stock market. They are driven by fundamental analysts, stock chart technicians, behavioral analysts and a variety of others who routinely look to the past, or build models of the future, on which basis they profess some insight on the probability that their chosen investment will either go up or down. They are hard to find, but some of these are quite logical, grounded analysis and worthy of paying attention to. Yet another group sound like astrologists, not making sense, or making promises that are too good to be true. These are the easy ones to avoid. The most difficult group are those that sound quite informed and use rational analysis yet reached flawed conclusions. This latter group will make you lose money, if you confidently follow their approach or advice.

Let me give you an example of this kind of analysis:

The author of this blog has identified that this year, the day before Thanksgiving was a losing day. He then conducts an analysis to to see when that happened historically and what the market did on the following trading day. He finds 10 occasions where the day before Thanksgiving was lower, and 3 of those 10 times, the following day the market was also lower, while 7 of the 10 times, the following day the market was higher. One would surmise therefore that there is a bullish bias that this next day upcoming should also be up. After all, 7 of the 10 times when this happened in the past, the market was up the following day. He also indicates that fridays after Thanksgiving historically, not just the ones that follow a down day, have been bullish. Moreover, he circles the two instance where the day before Thanksgiving was lower by more than 1% (which occurred this year), and those suggest that the following day could be very good winners.

The analysis shows that on average, the down days were down by 0.64%, while the up days gained 0.81%. And because there were more up days than down days, the average of all the occurrences was a positive 0.35%. This 0.35% positive return is a good tradable return from a statistical expectancy point of view. But is that the right way to look at this data?

I think not. Let me use an analogy to explore the concept. Suppose you were in the business of flipping coins (the market going up or down each day is equivalent to flipping a coin since it rarely stays the same, which would be equivalent to a coin landing on the edge). And suppose I told you that on reviewing your previous pattern of coin flips, we found there were 10 days on which you had flipped 5 consecutive heads. Further that when we reviewed what happened afterwards that 7 of the 10 times after you had flipped 5 consecutive heads, on the following coin flip you also got heads, while only 3 were tails. Now we have just gone five days in a row where you have flipped 5 heads. Would you bet $2.00 to win $1.00 that the next flip is a heads? How about $1.25 to win $1.00? The pattern analysis suggests you should, if you think there is a 70% chance of winning $1.00 (flipping a head) while there is a 30% chance of losing $2.00. And if you are using that reasoning, then you should be much more amenable to the $1.25 bet. But my guess is that you probably won't take either bet.

The instinctive answer is correct, even though the rationale many people give may not be. Most people, who did not pay attention to the statistics classes, say that after they have seen a streak of five heads that it is more likely that they will see a tails. Some might even be inclined to bet $1.25 to win $1.00 that the next flip is a tails. There is some real cognitive dissonance going on here, and it goes to show why people looking at statistical data or patterns might be misled. The essence of the problem is in figuring out the likelihood of your next flip being heads, or the market going up. And the simple answer is that it is equally likely that the next coin flip will be a heads or a tails (unless of course the coin is weighted on one side more than the other). Similarly, the market is equally likely to go up the next session, as it is to go down.

So what is the likelihood that the market would be up on the day after thanksgiving when it was down the day before? 50%! And what happens to this fine analysis when we look at the expected results based on those probabilities? We know that on average it was down .64% on the losing days and up .81% on the winning days. Therefore, one might surmise that, on average, there is a 50% chance we could be up .81%, and a 50% chance we might be down .64%. The resulting expectancy is .08% up. This is an expectancy so negligible, it might not even pay for the commissions, and certainly is not trade-able.

But, that chart above, and the analysis was so compelling with so many positives and so few negatives. Just as compelling as those five heads in a row pattern should have been to you. Analysis of the past make you more or less confident about rolling a heads next time, when they should not. If the market goes up today, it will be by chance and rarely will it have anything to do with what happened yesterday or two days ago!

Why was the iPhone delayed from the typical June refresh?

Much has been written about the next version of iPhone, that was not launched in the typical Apple June refresh. Most of the articles written have been rumors and speculation about what the new phone will look like or what technology will be included. I call this the "what" stories. They include stories that evaluate purported component changes or screen saver manufacturer design changes to conjure up new apple specs such as bigger home button, different screen sizes, etc. In the meantime, the more important question (at least from an investor standpoint) goes unaddressed.

Which Version Of Myself?

I was driving in my car the other day, listening to music piped from my iPod as usual. It's set to shuffle so I always get a changing playlist. Suddenly a tune from David Byrne, an old favorite, came bursting into my consciousness. Now, for those of you too young to remember, David was the brilliant founding member of critically acclaimed "Talking Heads". He is a pure artist know for his quirky sound, mind bending lyrics and collaborations with the likes of Twyla Tharp and Brian Eno. And, if you don't know who they are, then I am afraid you missed a lot of the "New Age," experimental sound and modern dance history.

Anyway, back to my story. So David in his classical style belts out the line: "I am just an advertisement for a version of myself"!

I need better advice!

I come to my advisors warts and all.

My first advisor points out all the warts that can be seen. I have learned nothing new.

The second advisor points out that some of my warts are ugly. I have not learned anything really new, but am now self-conscious.

The third advisor points out my visible and hidden warts. At least I have learned something new, but have not gotten closer to value.

A fourth advisor points out that some of my warts are deadly. Again I have learned something new, but am now scared out of my wits.

The fifth advisor points out visible and invisible warts, identifies those that make me look worse, and those that are deadly and leads me down a path of surgical removal and repair.

Why is it that in business or personal affairs, when we bring someone a proposal or come looking for advice we get one of the first four advisors? Why is it so rare for our advisors to not only diagnose, but recommend a corrective path? That is what a great advisor does.

To be really helpful, contribute a solution, don't just point out what's wrong!

Wow!

There are some images that have such an effect on you that the only thing you can do is say wow! How did the photographer get such an amazing image? What's your reaction?

Follow the link to see more wow images of the World At Night!

Matt Ridley: Down with Doom

By then I had begun to notice that this terrible future was not all that bad. In fact every single one of the dooms I had been threatened with had proved either false or exaggerated. The population explosion was slowing down, famine had largely been conquered (except in war-torn tyrannies), India was exporting food, cancer rates were falling not rising (adjusted for age), the Sahel was greening, the climate was warming, oil was abundant, air pollution was falling fast, nuclear disarmament was proceeding apace, forests were thriving, sperm counts had not fallen. And above all, prosperity and freedom were advancing at the expense of poverty and tyranny. 

[From Matt Ridley: Down with Doom: How the World Keeps Defying the Predictions of Pessimists]

There is a reason to avoid hospital visits!

Quote from SuperFreakonomics:

So it may be that going to the hospital slightly increases your odds of surviving if you’ve got a serious problem but increases your odds of dying if you don’t. Such are the vagaries of life.

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Making Sense of Investment Advice

The miracle of "compound interest" has been well documented. Investing to leverage this power can be richly rewarding if managed properly. Done poorly, one can easily create great damage to a portfolio of assets. And over the last twenty years or so I have done both.

Being the curious type, and like many personal investors, I have been on a quest to find that "holy grail" of investing, the practice, process, method, newsletter, chart or whatever, that would lead to incredible returns. I have read voraciously, analysed, tried, tested, listened to others, and yet the holy grail remains elusive. That said, I have learned a number of important lessons along the way, which are well documented in books written by some amazing students of the market and great investors, like John Bogle, Ken Fisher, Joel Greenblatt and Benjamin Graham. I thought I should share some of these in the hope that you could avoid some of the pitfalls. Here are some of the lessons I have learned:

Our Absurd Budget Debate

Michael Ramirez via IBD:

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[From Our Absurd Budget Debate]

Gobbledegook Or Just Plain Nonsense?

Friday, January 07, 2011
Say What?

From an actual Wall Street “research” report this morning—and, before you ask, no, this is not from “The Onion”:

We are upgrading 3M to Neutral as capitulation on the growth story and 2011 estimates should limit relative downside and make 3M once again somewhat of a defensive stock. While the negative dynamic of positive sentiment has turned modestly more favorable, stubbornly bullish consensus estimates for ’12, along with risks at Healthcare, keep us from moving to Overweight.

Anyone care to venture what this means?

Jeff Matthews
I Am Not Making This Up
[From Jeff Matthews Is Not Making This Up: Say What?]

Maybe as I get older, I am less tolerant of long convoluted explanations. Or maybe I am beginning to really understand the plain beauty of a KISS ("Keep It Simple Stupid") strategy. But after reading this one, I have to admit that I could not understand what the writer intended.

Globalisation: The redistribution of hope | The Economist

The redistribution of hope
Optimism is on the move—with important consequences for both the hopeful and the hopeless
Globalisation Dec 16th 2010 | from PRINT EDITION

“HOPE” is one of the most overused words in public life, up there with “change”. Yet it matters enormously. Politicians pay close attention to right-track/wrong-track indicators. Confidence determines whether consumers spend, and so whether companies invest. The “power of positive thinking”, as Norman Vincent Peale pointed out, is enormous.

For the past 400 years the West has enjoyed a comparative advantage over the rest of the world when it comes to optimism. Western intellectuals dreamed up the ideas of enlightenment and progress, and Western men of affairs harnessed technology to impose their will on the rest of the world. The Founding Fathers of the United States, who firmly believed that the country they created would be better than any that had come before, offered citizens not just life and liberty but also the pursuit of happiness.

Not that the West was free of appalling brutality. Indeed, the search for Utopia can bring out the worst as well as the best in mankind. But the notion that the human condition was susceptible to continual improvement sat more comfortably with Western scientific materialism than with, say, the caste system in India or serfdom in Russia.

Now hope is on the move. According to the Pew Research Centre, some 87% of Chinese, 50% of Brazilians and 45% of Indians think their country is going in the right direction, whereas 31% of Britons, 30% of Americans and 26% of the French do. Companies, meanwhile, are investing in “emerging markets” and sidelining the developed world. “Go east, young man” looks set to become the rallying cry of the 21st century.

[From Globalisation: The redistribution of hope | The Economist]

I grew up reading "The Economist". I remembered looking forward to the addition of each new edition of the magazine to the library of my school in Guyana. It was the source of unbiased world news, analysis and opinion. Back then, there were not many choices, but the thing that impressed me most, was the way they covered the stories that mattered. An unbiased, well written, thoughtful analysis of the events around the world. Since then, I have only grown fonder and more appreciative of this journalistic "tour de force". I don't always agree with their viewpoint, but have never felt they were pushing an agenda. All this to say, "The Economist" is among one of my most highly recommended readings. Click on the link above to see what I mean by a well written article. As an unabashed optimist, I just love the last paragraph. You will just have to check it out yourself!

Happy New Year!

Happy New Year! Three words oft repeated during the holiday season. A greeting to friends, family, and even strangers, it is heard so frequently as to appear vacuous or inane. Yet, upon reflection, there is so much more going on here psychologically. At least it appears that way to me.

The new year seems like a wonderfully refreshing reset. A time to take score, to reflect in the past, and to consider the future. The optimism it engenders always invigorates to further success, be it world peace, more regular additions to a blog, weight reduction, a new job if one has been unemployed, better investment returns, or myriads of other personal wishes. Amazingly, it does not seem to matter, the kind of year just ended. It could have been a lousy or an outstanding year, yet the season wishes and impressions are so powerfully motivating that it's easy to feel that the following year can be even better.

I know that the reality bug slips in quietly and quickly after the season has run it's course, bringing with it a dampening effect, trying to deflate our optimism. And I know that many resolutions frequently end up forgotten. Nevertheless, the potential for goodness is so great, and the opportunity for success so awesome, that it is worth going through this uplifting process. After all, success is better achieved through optimistic action than pessimistic inaction.

So, to all I say, Happy New Year! May you do something that makes this year your best yet!

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