An example of why there is money to me made in the stock market

[LA_Price]

I heard this in my stats class today and think it is a good model of stock market.

you're conducting a study with a biased coin but you don't know whether it is biased heads or biased tails. so you conduct a study. The way it works this. The first person flips the coin and has to say whether the coin is biased heads or tails. The following person will know what the previous people said but won't know what the actual outcomes were. So the first person gets a head so they say it's biased heads. Then the second person goes and gets a head so they say the coin is biased heads. Now the third person flips and gets a tails but since the previous two said heads he says it's biased heads. Then the fourth person goes and gets tails but he says it's biased heads since the previous three must have all been heads. You can see that it will be very hard for anyone to say it's biased tails because they are reacting on the incomplete information of the previous flippers.

Now if someone was to take the coin and do 100 or 1000 trials they would know pretty well the true bias of the coin which may or may not different from the results of the test.

People make decisions in the stock market very much like this coin. they don't bother to do the research for a company themselves but rather rely on the information of others who are acting on the advice of others who may or may not have done research themselves. For this reason there will always be inequity for those who are smart enought to spot it. Just an interesting example that I thought fit well here.

[crazy canuck]

Interesting post, however I have to disagree with you. The market price is the weighted average of investors' opinions of the future price of the financial instrument. So financial markets are excellent predictors. Remember the terrordaq idea? Also, the florida futures market predicts the weather better than conventional meterological methods. So this means that the market price most of the time is a fair and not biased price. And therefore it's pretty hard to beat the market even if some idiots participate.

[lorinda]

Moral of the story: Be the first one to flip the coin.

Lori

[LA_Price]

yes but many times the price of stock is not indicative of it's true value. Some companies sell at 50 to 60 times their earnings because of future predictions or hype which may never materialize . All people own then is dreams. They eventually crash like in the last tech bubble. Other times as when Warren Buffet bought the Washington Post Co. you could have sold the companies entire assets and it would have been worth more than what he paid if he bought all the shares. So I think discrepencies do seep through if you're good enough to spot them as investors like Warren Buffet are.

[DesertCat]

[ QUOTE ]
Warren Buffet bought the Washington Post Co. you could have sold the companies entire assets and it would have been worth more than what he paid if he bought all the shares.

[/ QUOTE ]

I think your example is apt, but underpriced securities aren't trivial to find. The saying goes, the market is frequently efficient, but not always so. Finding those situations where it isn't takes elbow grease and patience.

When the washington post got so cheap, it was during a terrible bear market and investors didn't know where the bottom was. They were also scared by the high level of family ownership and control. Warren's genius was that (unlike most fund managers), he was ecstatic if the stock price declined further after his purchase, as it offered him the opportunity to buy more at even better prices. And he judged the Grahams as good managers who treated their minority shareholders fairly, so their majority control wasn't a concern.

[Yads]

[ QUOTE ]
Also, the florida futures market predicts the weather better than conventional meterological methods.

[/ QUOTE ]

I find this very hard to believe.

[ctv1116]

I don't. Florida futures markets takes into account conventional meterological methods, and then tries to go beyond that.

[J_V]

Much more money is on the line for the major futures players than the local meteorologists. It stands to reason that the bigger the reward, the harder the research.

[crazy canuck]

I find this very hard to believe.

Article on terrordaq (http://www.polkonline.com/stories/080303/opi_terrorismmarket.shtml)


[ QUOTE ]
Financial markets are incredibly powerful aggregators of information, and are often better predictors than traditional methods. The examples are numerous. The futures market in orange juice concentrate is a better predictor of Florida weather than the National Weather Service. The Iowa Electronic Markets outperform the opinion polls in predicting presidential election vote shares. Hewlett Packard ran a market forecasting printer sales that outpredicted any of its analysts. The Defense Department should be applauded for admitting to its own limitations. Last winter we studied a market in "Sad-dam Securities" that proved to be a good predictor of the probability of war in Iraq.

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[edtost]

so, in better terms, the market's inefficiency is what allows people to beat it?