Re: Stupid but essential question
 

It's fairly easy to beat the game in-itself, the hard part is beating the rake. If you must beat the rake to beat the game, then the in-itself of "beating" the game BECOMES the beating of the game + the rake; so to beat the game to a higher degree, with everything else staying the same, you only need to find lower rake. It is hard to find lower rake than the S&P 500, and thus that much more difficult to beat that game, even if, all other things equal, you are playing better.

Re: Stupid but essential question
 

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It should be obvious that professional traders get a better return on capital than investing in the S&P, but I don't really think you have any idea what a pro trader on wall street does.


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Of course I don't. Did you read the OP?

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How can there be a huge amount of traders employed at banks and hedge funds if they don't get a better return on capital than the S&P.

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You're asking my original question back to me.

eastbay

Re: Stupid but essential question
 

For one thing, investing implies more of a long term strategy. Find a good investment and let it sit and grow.

A trader is trading the assets of the firm to make more money. They do stuff like look at the implied interest rates in a soy bean futures market compared to long term bond yields in Germany. If there is an inconsitency - i.e. I can essentially borrow money at 5% and invest it all at 6%, then I pull the trigger. The opportunity might only be available for a few minutes, but the math models detected it and alerted the traders. Again, I'm not a trader, but that's the basic idea.

Re: Stupid but essential question
 

I have seen numbers that show that most mutual funds don't beat the S&P 500. This does seem like powerful evidence that an individual investor would have an extremely difficult time beating the S&P 500, since they probably have a day job and don't have the tools available to the professional fund manager.



Mutual fund managers have restrictions that makes it impossible for them to beat the market. Also, it is much harder to generate significant returns with 3 billion than with 10 million. So actually the fact that mutual fund managers perform poorly is not evidence that markets can't be beaten.

I'd say to beat the market is pretty easy if you do your homework, but to beat it significantly and to make a living off it as an individual trader is nearly impossible (unless you have a fairly large capital to start with).

Also, regrading trading there are many types. There is directional trading, derivative trading, market making, arbitrage (and each of these have numerous styles)etc.

Re: Stupid but essential question
 

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True or false?

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False.

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If false, why is this claim made so consistently?

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Most people can't beat the market. Most people are better off just buying an index and holding. But then again, most people can't win 2BB/100 at limit hold 'em. Also, most people can't make a 15% ROI in SNGs, and most people can't win at sports betting. But in each case, there are some people that can. So for your average person, the index fund route is generally the way to go. But there always have been and always will be traders/investors that can outperform the market.

Re: Stupid but essential question
 

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True or false?

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False.

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If false, why is this claim made so consistently?

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Most people can't beat the market. Most people are better off just buying an index and holding. But then again, most people can't win 2BB/100 at limit hold 'em. Also, most people can't make a 15% ROI in SNGs, and most people can't win at sports betting. But in each case, there are some people that can. So for your average person, the index fund route is generally the way to go. But there always have been and always will be traders/investors that can outperform the market.

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Thanks, I figured this was probably the most plausible answer.

I can beat SnGs for several $K a month, and learned to do this within 6 months of playing my first hand of hold 'em. What's that got to do with anything about stocks? Maybe nothing, but maybe something, and I'm trying to learn one way or the other.

The main problem I have with poker as a money making venture is that it is not particularly scalable. The higher you go in stakes, the tougher the games get. With more risk comes less return (proportionally speaking) in general as you move up the stakes ladder. It is self-limiting.

Somewhat like sports betting, investing in markets generally doesn't work this way, as far as I can tell. If you find the opportunity, you can take on more risk for more return by making bigger bets. There is no saturation limit for the individual investor, as far as I can tell. So, I am intrigued by the idea that whatever skills I developed for winning at poker may be, at least in part, transferrable to a new kind of opportunity that is scalable rather than self-limiting.

This is all pure speculation at the moment as I'm (obviously) a complete novice at any of this. But I have read many times (and can see by some examples) that the skills for beating gambling games are applicable to beating the markets. I am trying to figure in what sense and to what degree this is true.

So I'm intrigued and ready to start learning, but I'm not sure where to start. I have read much "popular" literature on investing, motley fool style, and most of it leaves me cold. It is written for people who should buy an index and hold, and probably also should never play poker.

But I'm a poker player and a curious analyst, and I want to learn how to think about the markets beyond "buy an index", but most of what I see passing as analysis seems kind of silly. The language around "technical analysis" seems like 99% hokum. My BS detectors are in full swing when I read about "wave theory" and "support" and "resistance" and "breakout". There's no foundation there. In poker the statistics of the deck provide a foundation and the rest is making good guesses about the people playing the game.

Obviously the dynamics of the market are infinitely more complex than the dynamics of a poker game with 10 players and 52 cards.

But apparently some investors/traders are doing something right, and I suspect they are doing it with at least a semi-analytical approach.

So, what's my next step? Who's doing the real analysis and where do I learn about it?

eastbay

Re: Stupid but essential question
 

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But I'm a poker player and a curious analyst, and I want to learn how to think about the markets beyond "buy an index", but most of what I see passing as analysis seems kind of silly. The language around "technical analysis" seems like 99% hokum. My BS detectors are in full swing when I read about "wave theory" and "support" and "resistance" and "breakout".

eastbay

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You are exactly right. I give little credence to anyone who claims to use technical indicators successfully, most studies show them as hocum.

CrazyCanuck did a great job of explaining why mutual funds don't beat index funds in the aggregate, mainly fees, an awkward structure and too much money to capitalize on small opportunities.

RacersEdge gave a good description of how some professional traders make money. I believe what people call "professional trading" is always arbitrage investing, or trading on informational advantages.

Arbitrage investing means you can essentially find the same thing selling for two different prices, and you make a trade to profit from it. Informational advantages means they have some insight into order flow that others don't.

The most successful long term investors are typically value investors. Ben Graham's books lay out the theory of value investing just like TOP does for poker. Essentially, an investment is worth the stream of cashflows you can reasonably expect from it over time, discounted for time. Discounted for time means that cash the company will get next year is worth less than the same amount of cash on hand, you "discount" it by a reasonable interest rate it would have earned had you the money today.

This is the guide of a very successful group of investors, most importantly, Buffett, but there is a large group of value investors who've beaten the market for decades applying these identical concepts in very different ways. Graham focused on cash heavy companies, Buffett moved onto franchise companies that had very predictable and quantifiable earnings growth.

For example, the leading mutual fund manager today, Bill Miller, uses the same intellectual framework, but applies it to less predictable growth companies than Buffett would. Bill's beat the indexes every year for the last 11 (not sure if he made it last year), an unrivaled record.

Even Peter Lynch, who loved growth companies like Miller does, bought them on a fundamental valuation model.

You can learn this stuff for free by reading Buffett's annual shareholder letters, the last twenty plus years or so are on Berkshire Hathaway Web Site. Ben Graham's Security Analysis and Intelligent Investor are the bibles of value investing, but I have to warn you they are pretty dry reading, and getting very dated. If you can absorb the principles they are well worth it. I think there is a new version of Intelligent Investor that was updated with modern notes and explanations, I'd try that first.

Re: Stupid but essential question
 

Eastbay:

When someone refers to not being able to beat the S&P 500 they are referring to long (hoping for a stock rise) only, equity (stocks) mutal funds which are buy and hold strategies with light trading and no-leverage. Traders who work for Wall Street firms or hedge funds can buy long or sell short (hoping for a decline) anything they want where they think they can make a gain and they can employ tremendous leverage (they can borrow money to invest greater amounts - think home mortgage). These traders can make or lose tremendous amounts of money and go from hero (think yacht, mansions, Red Sox - John Henry) to goat (your fired!!) in a matter of days, remember these guys have a BR of hundreds of millions or even billions to invest. If you're a trader and have a 5 year track record of making 12% or better year after year - the money will find you and soon you too will own your own baseball team. The trick is that when you manage all that $$$ you actually move markets as you invest and it becomes harder to find good investments that generate high ROI. That's why the largest mutual funds like Fidelity Magellan are so mudane because they just can't find many places to invest all that money and wind up basically investing in the S&P 500 stocks.

Re: Stupid but essential question
 

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But I'm a poker player and a curious analyst, and I want to learn how to think about the markets beyond "buy an index", but most of what I see passing as analysis seems kind of silly. The language around "technical analysis" seems like 99% hokum. My BS detectors are in full swing when I read about "wave theory" and "support" and "resistance" and "breakout". There's no foundation there. In poker the statistics of the deck provide a foundation and the rest is making good guesses about the people playing the game.

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Sure, some of that stuff is hogwash, but it is wrong to say that there is no foundation there. Most traditional market theory (like the CAPM, for example) assumes rational and efficient markets and rational market participants. In reality, there are examples on a daily basis that blow this assumption to hell. Technical analysis is rooted more in mass psychology and helps to understand the sometimes collectively irrational behavior of market participants. I personally use a combination of fundamental and technical analysis (primarily fundamental for selection and technical for timing), and it has worked very well for me.

Re: Stupid but essential question
 

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I personally use a combination of fundamental and technical analysis (primarily fundamental for selection and technical for timing), and it has worked very well for me.

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Let me suggest that your success is rooted more in your skills as a fundamental analyst, than in technical analysis.

No technical analyst seems to be able to pass the simplest test of success, i.e. cutting charts in half and predicting whether the stock went up or down based on the first half of the chart.

I frequently make stunning calls on whether a stock I want to accumulate will go up or down in the next few hours or days. I would think I'm really good at short term predictions if I could only forget the equally many times I was totally wrong. Sometimes people just remember their successes.

The good news is if you are skilled at fundamental analysis, it almost doesn't matter if you mess with technical indicators or not, since they won't matter. You just have to buy when cheap, and sell when expensive.