Question for All?

[adios]

If you pick a stock and it goes up say 20% in a month and reaches your target price. Have you been lucky or good or both? I guess my question is how much does luck play in making money in the financial markets especially if your holding periods tend to be very short i.e. say 3 months or less? I mean in poker you can play well and lose for short periods of time or play poorly and win for short periods of time (actually the periods can be longer than most people suspect depending on your skill level etc.) just due to variance. How much of a role does variance play in trading and/or investing in the markets especially when holding periods are short?

[Ray Zee]

love to burst the bubbles here. but i would say its 100% luck in both the short and long term in the market. the long term trend would be up because of inflation and productivity. but any individual would have all luck deciding his fate.

unless you knew something or figured out something others dont know. then its no longer luck at all. your results from that will be higher or lower due to luck of the market movements. so the old saying only buy what you know about is true.

for most all stock investors all you are doing is trying to beat inflation.

[Javelin]

Skill is not being right but being right for the right reasons. In the long term, it mostly comes down to fundamentals so being right about the big picture will eventually payoff (if you can take short term pain). People who thought stocks were overvalued in 1999 were right but anyone who shorted the market in size would have been wiped out... so while they were right, it didn't do them a lot of good. So even trading the fundamentals, there is a lot of luck involved.

In the short term there is a lot of random noise so its very difficult to attribute performance to fundamentals. It is possible to be right about technicals and have a short term view on the market... thats if you believe in technicals which a lot of people don't.

So is there such a thing as a good trader or just a lucky one? I think there are good traders... i definitely KNOW there are bad traders, so by that logic there must some good ones!

[adios]

I'll have more comments later but I'd like to perhaps amplify one comment:

"i definitely KNOW there are bad traders, so by that logic there must some good ones!"

And by this logic if you somehow got truthful advice from good traders, you would do well yourself.

[Zeno]

"so the old saying only buy what you know about is true."

This is why I have problems with the diversity concept and why I posted about it a few weeks back. Prudence does seem to dictate that a certain percentage of your money should be invested in the "standard way". But I think a certain percentage of your investment money should go into "things that you know".

For example, I have concentrated on purchasing only two stocks, Motorola and GE (I view these as long –term investments, meaning at least 3 years or more). Nothing else. But I have also set aside money to purchase a Roth IRA again this year and have contributed to a 401k plan (which just ended by the way because of a job change). So if X were the amount of money you plan on investing in one year, what percentage of X would you put willing to put into “non-diversity investing”? This may of course depend on your personal risk tolerance but I think it is a valid question.

I would like to come up with a plan of savings and investment that allows me to take a more substantial risk, with a certain percentage of my earned income, to hit the home run with. Would this type of investing really depend that much more on random chance (luck) than the supposed more "moderate" way of investing?



"for most all stock investors all you are doing is trying to beat inflation."

Can't the same thing be said of most ways of investing including bonds, precious metals etc. So is it all luck? /forums/images/icons/shocked.gif

-Zeno

[Ashe]

Nothing is sure in the short term… all you can do is make educated bets and hope that they hold. (But you can make money)

I trade mostly in call options. (I have other conservative investments too. I just don't actively trade them.)

When dealing with options, I am forced to look at and decide on different time frames to invest.

What I have seen, when focusing on different time horizons, is that even though a stock is undervalued, and you know it’s undervalued, you still don’t know when the market will realize this.

Example, I had picked JPM when it was trading about 20 (less than year ago, now its in the mid-30s). I knew this stock was undervalued, so I bought some call options. Well, time went on and they expired, costing me my entire investment. So I bought some more calls. They expired too. By the time I finally started making money on this position, after buying my third set on options, I was so far behind, that as soon as I recover my losses, I sold out the position and netted a great profit of $0.

Now, I had a great idea, but due to time constraints I made no money on these options. Thankfully, I started a DRIP in JPM around the same time.

After writing this, I’m kinda wondering why I’m still trading in options. The thing is I’m making money doing it, so I would say that you can make money in the short term. It’s just a lot riskier. (In the event of a market crash, all my calls would be worthless.)

Ashe /forums/images/icons/smirk.gif

[adios]

IMO excellent comments in all the posts to this point. To amplify your thoughts a little:

1) When you speculate in BUYING options you are limiting your downside per trade, therefore if a catastrophic market event goes against your position, you've defined the worst case scenario. To point out the obvious, SHORTING puts limits your downside as well as SHORTING calls does not.

2) I would think that trading options you've defined an expected value (EV) for the trade. Options are designed to be 0 EV sans transaction costs. So to point out something that Ray stated you have to know more than others about which direction the stock will move and when it will do it. The other thing about any strategy you probably should analyze alternative strategies to see if they'd be more profitable than buying the options. Please don't get me wrong about options, David Sklansky posted a trade when the Martha Stewart bruhaha first hit the wires that he was going to do with options and it netted an 8 fold return I believe. He stated the reasoning very clearly as well.

[Ray Zee]

zeno, yes all investments are just trying to beat inflation. of course that is not what people think. you might not invest if that was what you really knew. but think about it. that is what makes prices of anything ultimately rise and stay up. it has its down effects also.
diversifying your portfolio is only good for managing risk. you invest for the future so that when you retire you have a way to maintain a high living standard. so that is the main reason to diversify, so you dont put that in jepeordy by putting too much in one place. in general everything you invest in you should know alot about. buying things just to diversify is foolish as is putting all of it in a few stocks and risking a lifetime of work for a perceived chance at a higher return.
diversity is also investing out of the market. as the market as a whole rises and falls together. so you should have real estate, and tangible assets as well. could be antiques, gold, old cars, or what ever gives you pleasure.

trying to hit the home run. remember the home run hitters also have the highest strike out %.

[brad]

well i dont think this is an opinion question. i think u can quantify it much as in poker.

as for win rate i dont know

but

i think for variance with all the software out there i think u could do a sim (like a monte carlo sim) to determine it at least roughly (use historical data but obvoiusly you know ).

sounds like it wouldnt be any use (hey it tells me when market goes up im lucky /forums/images/icons/smile.gif ) but maybe if u just look at a very specific segment of the stock market then it might give u some results.

[Aragorn]

It is a complicated question. First, doing it once doesn't prove a thing. If you can do it repeatedly, you are probably exhibiting some skill.

A one-month time frame is probably luck. But it depends on whether you are a technical or fundamental trader. Fundamentals take a long time to overcome the noise in the market. Technical factors are more likely to appear in the short run.

But given the basic fact that almost no professional can outpeform the market over an extended period, I think most amateurs who think they can are deluding themselves.

[adios]

"A one-month time frame is probably luck. But it depends on whether you are a technical or fundamental trader. Fundamentals take a long time to overcome the noise in the market. Technical factors are more likely to appear in the short run."

This would imply to me that the success of trading on technical factors is determined by randomness of price changes (akin to playing craps) or that one who knows how to correctly analyze technical factors can predict near term prices accurately enough to make a profit. The latter would indicate market ineffeciency that can be exploited. As far as fundamentals lets get back to Rays contention. The price of a stock represents the present value of future earnings for the most part. If you don't have more knowledge about the fundamentals than the market (collective of investors) does, how could you possibly expect to estimate the value of a company better than the market does? Not saying that one can't do either i.e. analyze technical factors to predict price movements or analyze fundamentals more astutely than the market, just stating what the reality is and one needs to be aware of. I like your statement regarding noise of the market.

"But given the basic fact that almost no professional can outpeform the market over an extended period, I think most amateurs who think they can are deluding themselves. "

Actually I agree but I'd add the caveat that using the advice of someone more knowledgable could improve results a lot.

[brad]

'If you don't have more knowledge about the fundamentals than the market (collective of investors) does, how could you possibly expect to estimate the value of a company better than the market does?'

i see two possibilities (im no trader btw)

a) you exploit the time factor (perhaps relying on the fact that at least some investors must be 'lazy'). note this is not having more knowledge.

b) heres the big point. you gamble better. say for example when its 50/50 whether you lose 50% or gain 75%. easier said than done i guess. perhaps predicting when the market will overbid a stock or something.

curious what your strategy is if you trade short term.

[Mark Heide]

If it goes up 20% in one month you are lucky unless you have inside information, and then you're a crook.

I think making money in the stock market is approached by professionals as risk management. That's why in the 401K plans investment professionals say you can take more risk when you are young, but not when you are older. This is the approach that I take and like the strategies that Warren Buffet uses.

Anyway, I remember a 60 Minutes show where they had a professional stock broker pick stocks and a monkey pick stocks. The monkey made the most money.

Good Luck

Mark

[adios]

In some ways putting money in the financial markets seems to be the ultimate suckers game to me and in others ways it's the most fascinating, stimulating, challenging,mind boggling, and interesting activity I can think of.

The Tale of Two Stocks from the Internet Bubble

Let's say you bought EBAY and SUNW in January of 2000 for $75 and $37 a share respectively (split adjusted) with the intent of holding them 5 years irregardless of market swings. In December of 2000 you'd have seen EBAY trading at $33 a share and SUNW trading at $27 a share. Both appeared to be big losers but SUNW seemed to be less so.
Yesterday EBAY went out at $112 and change and SUNW ended the day at $3.97 a share. EBAY has returned it's investors a compounded rate of around 13% per annum since January of 2000 while SUNW has collapsed in price. In the hypothetical situation I proposed there's still 1.5 years left so maybe you should sell your EBAY stock and bet it on SUNW. I wouldn't. I think the preceeding sums up the problem with "investing" in stocks for the most part and why it's hard for investors to hang on to stocks in lieu of trading a lot. Personally I would doubt that a person bullish on SUNW that tried to actively trade the stock would make money if they never took a short position since January of 2000. On the other hand, a bullish investor in EBAY I would think would have probably made money by actively trading since January of 2000 especially if they didn't short the stock, how much is the question. For those that can reliably predict turning points ignore what I just stated we need to hear how you do it /images/graemlins/cool.gif. In the stock market holding periods of 1 year seem to be an eternity let alone 3.5 years, let alone 5 years. But the data seems to show in my mind that long holding periods are required when investing. Certainly valuations are based in part (big part) on future earnings that are estimated AT LEAST 5 years out. Is there a point to this rambling post? Well yeah one is that the valuation of stocks can be very wrong at times. I mean how much have the "fundamentals" i.e. long range future earnings expectations for EBAY changed from December of 2000 to July of 2003? Put another way, how much would future earnings expectations have had to change to make it greater than 3x the December 2000 valuation? I concede that in a muti-stage dividend discount model there are other parameters that would effect the valuation. Personally I don't think the earnings expectations have changed much but what fluctuated was the risk premium which can rise and fall due to economic uncertainty as well as other things. To put it another way there was a lot more fear in the market than there is now. Ok what about SUNW? Well for this company the fundamentals have changed a lot IMO or at least the changes in fundamentals are much more apparent now than in January of 2000. I will conclude my rambling by stating that a very astute investor, one that was very knowledgable about SUNW's business and EBAY's business in December of 2000 would have loaded up on EBAY buying the dip and shorted the hell of SUNW realizing that his January of 2000 bet was wrong. So I guess this is more or less agreeing with Ray about knowing what you own.

[Warren Whitmore]

100% Luck.
Some people were lucky enough to be born smart and some were not.

Take the top 25 investors in the world as defined by average rate of return for the last 25 years and you will find there average intelligence to be much greater than the average non investor.

[Aragorn]

How well a stock is doing 1 month after you buy it only matters if you are going to sell the stock 1 month after you buy it. Otherwise, it is mostly noise.

[Wildbill]

A crook? I am very privy to my company numbers and there is no restriction on my activity like there is for our more executive employees. Now I and most others have ethical reasoning and as such don't trade on it, but it would be criminal for me to do so. I think you see this all the time in the market, a runup prior to earnings or news. Its likely people in the know driving this, but it isn't necesarily criminal.

[Mark Heide]

Wildbill,

When I refer to inside information, I specifically mean information that the public has no access to. A perfect example would be a drug company that was depending on FDA approval and you knew ahead of time that the FDA will not approve it because someone at the FDA told you. Now, if you knew from the understanding of your business that there may be a 70% chance that the drug many not be approved you would not be trading on inside information, but trading on the knowledge of your product.

Mark

[Ray Zee]

it is insider trading if you buy ahead of time knowing something about the earnings report coming out.it is criminal or am i missing something.

[Ashe]

"But given the basic fact that almost no professional can outpeform the market over an extended period, I think most amateurs who think they can are deluding themselves. "

The really talented trade their own money and the money of the rich (individuals and corporations), and because they don’t need anything from the public, most people never hear of them. And they win consistently.

Basically, investing is about experience and education, and how one applies the two to their decision making. Luck plays a roll, but as in poker, the better players come out ahead. /images/graemlins/smirk.gif

[Wildbill]

Actually my understanding is that you can personally trade at anytime as long as you haven't agreed in contractual terms to limit your trading to windows, which is usually required of top officers only. What would make it insider trading is if I called up someone else and told them what I know and they went out and traded on that specific information. At my company there must be 100 people at least that know the earnings that we will report days in advance, people that I doubt have any restrictions on trading. Some companies make you give them access to your trading accounts and could reprimand you for making obvious trades, but for the most part I don't think there is any crime in doing this as long as you do it yourself and don't get others involved. That would be a violation of confidentiality agreements anyways so that in itself would be highly unethical, if not illegal.

I am telling you that it certainly happens and there is almost no way to enforce it. Just look at the charts for 3 or 4 days before earnings release at some of the blowout numbers given. I bet 95% or more will show some pretty confident looking buys. If the SEC were to investigate some of the buyers, they would simply say "hey I know earnings were coming and the price action told me to expect something good so I bought". Its almost impossible to clearly tie someone to insider trading without clear and unmistakable evidence that someone revealed something to them. Same goes for things like FDA trials. Now being ethical is a different story, but for criminal issues I think things are a lot looser than you presume. Of course I don't have any legal standing about this so don't take this as legal advice, just my personal understanding. And this is the case at every company I have ever worked at with publicly traded shares.

[Wildbill]

I thought about this overnight and here is what I think. Whether you are lucky or not doesn't necessarily matter. Luck is a part of almost any venture you take so basically what you need to do is forget about the particular cause and just mark up a "winner". Where people get into trouble is when they are essentially fooled by luck. That is what is at issue here. Remember when you buy a stock there is a pretty wide window of potential outcomes and a 20% return would have to be considered very possible in most cases. I would have to think that lucky is more along the lines of doubling in a month, not just 20% gain.

Where luck becomes an issue is if someone hits 7 winners in a row and starts thinking he is a genius. He should remember that just like the spectrum of possible results for a single stock, the possibility of hitting 7 winners in a row is out there, just as much as 7 losers in a row was as well. If he starts thinking its all about his talent and ignoring the fact that maybe he was running good then this person gets into a whole world of mess. That is why before investing, think much like professional gamblers must. Know what rate of return you should expect (be reasonable) and if you are above it after a period of time be careful not to get burned if you results regress back to something closer to what you would have expected. In other words if your portfolio goes up 30% over 3 months, don't up your individual investments 30%, but instead keep your sizes about where they were before, if not lower, to avoid getting burned by regression to the mean.

[Ray Zee]

as far as i know its illegal to trade on any info not publically available. just like with martha stewart. she was just told to sell by an insider and she did. who wouldnt. but its illegal. same as if you heard the ceo in a bar say that the earnings were rising. you would be trading on insider info and illegally.
you are right in that it is impossible to enforce unless you are high profile. then they destroy you. and they should.

[Wildbill]

But Ray as I keep saying what about info you know yourself from your position? I would guess that drives a ton of the runup volume. And what about non-specific info? Put it this way, say you met me for drinks one night and you knew my job gave me concrete numbers. I tell you "I would definitely look into buying my company's shares now" I say nothing more, but you know that I am privy to reliable numbers. Is that insider trading? I mean I might have said the same thing a month ago when nothing was going on, but you are aware earnings come out soon so you know why I am saying that.

Also realize that even those of us that know all this still aren't able to predict share prices all that well. I might think our number is strong, but the market could be focused on something else.

[Ray Zee]

it is all illegal but the degree is the question. any time you trade on privy info it is insider trading. i bet you could find the sec parameters somewhere on the net.
if you said it when you had no knowledge, you didnt break the rules. if you did it when the earnings were known to you , you just put yourself in jeopardy.

[Wildbill]

I read some sights and they are unclear at best. For example what is material? If I know my company is going to acquire XYZ for $5 share more than its trading at and is going to announce it within a day, yeah I see that is insider trading. If I know that they are going to report 50 cents earnings when the street expects 48 cents, well that isn't so clear. After all I could argue that the company has regularly reported earnings above street estimates or that many people were expecting the company to beat earnings, they just weren't willing to put it into an actual change in estimates. Like all things, there are just so many shades of color out there.

[Ray Zee]

what you are arguing is whether or not you could convince them its not insider trading or whether you could be procecuted. most likely with those senarios they wouldnt bother you at all. its too hard to prove and they are looking for big fish as they are under staffed.

it still falls under the--if you trade on privy info it is illegal. or if you give out that info for someone else to trade on.