I've been trading options occasionally for several years, and it's a tricky market. The small investor is preyed on by a slew of options trading seminars and "educational websites" that teach complicated and (due to commissions) expensive strategies -- with some of the more exotic strategies, like condors and butterflies, you could be trying to yoke four different options together. And anyone who has traded options knows how illiquid they can be compared to equities, making those multi-option trades very difficult to pull off effectively.
In my opinion, LEAPS (Long Term Equity AnticiPation Security) are about the only derivative that I feel worth using. When you first start option trading, the front-month options with their bargain basement prices seem like the way to go -- buy a stack of them ahead of an earnings call and wait for the surprise to make the option pop. In fact, that strategy -- essentially, of buying very out of the money options, letting most expire worthless and occasionally winning big enough to compensate and profit on the few -- is the strategy that a primary proponent of the inability to know anything about the future action of the markets, Nassim Nicholas Taleb, uses in his options trading. It's not necessarily a bad strategy, but one that I find takes an incredibly strong stomach and one that can often see you losing a lot of money and doubting yourself when you haven't made the big score. Sounds like gambling.
With LEAPS, there is still the possibility of losing the entire investment, like in any option that might expire worthless at expiration. But what I like about LEAPS is that you are able to make time more of an ally -- for most equities these days, a year or two is enough to see significant change in market value (unless, and this is quite possible, you choose an underlying stock that remains stagnant -- there's no perfect strategy in investing), and there is a definite exit time for the strategy. Although you won't lose your investment in a stock, it's quite possible that you will see the same loss and yet continue to hold on to that position while you wait for it to return to breakeven. Unless you specifically invested in that stock with the intention to hold it indefinitely, I view that as a bad trait of an active investor -- being anchored to a position when that capital that is locked up can be deployed elsewhere. The freer your capital, the better off you are.
Tuesday, August 22, 2006
Technically, Fallacies
There's a division in stock market philosophies that gets played up repeatedly: technical versus fundamental analysis. Fundamental analysis, though having its own problems, tries to ground itself in some basic qualities of a business -- how much money it has in its coffers (although the example of Enron and its ilk show that even accounting sometimes can't be trusted). Technical analysis, with its candlesticks, Bollinger Bands, flags and head-and-shoulders, spends a great deal of time looking at graphs, backtesting theories against old data and generally doing a good job at imitating empiricism. Ironically, it appeals to people who believe themselves rational... or maybe scientific?
There's a casino game called baccarat, one that isn't too often played but has a relatively small house edge (blackjack being one of the few that has a lower house edge). There are two sets of cards that come out for every round of the game, and although initially seeming complex, the play boils down to betting on which of those sets is higher or if they are equal. That's fine and dandy, but one of the things that casinos do is produce a baccarat scoresheet, which is essentially just a long rectangular grid of squares. Gamblers take that sheet and through their own systems, attempt to track the results of previous rounds and predict the results of future rounds. Since baccarat boils down to a sort of coin-toss, and anyone with a basic knowledge of odds knows that a series of coin tosses are completely independent (each toss has a 50% chance of being heads or tails), it's obvious that the only thing those meticulously recorded histories are doing is giving people the illusion of control. In fact, it's been proven mathematically that betting solely on the banker for every hand is the optimum baccarat strategy -- but people hate that, because... it's boring. So we discover the crux of gambling -- entertainment. This same urge is what drives investors and traders to develop theories that they feel might assist them. Essentially, they're all gamblers, but with longer timelines and more sophisticated systems.
One might argue that the stock market, being influenced by the actions of other players, means that paying attention to historical trends has a strong basis. After all, in poker games with players that you see consistently and learn to distinguish, knowing their previous play matters tremendously. Why doesn't the same apply to markets? Simple. Markets are composed of a group of people making decisions that are 1. too numerous to easily account for; 2. follow any infinite variety of systems; 3. interact with themselves (when people look at what the market is doing to determine what to do in the market -- they are the market). Computationally, even the idea of trying to model that behaviour is beyond our means. And still, in both cases, poker and the markets, we can only think about future actions as probability -- the passive, fish-like poker player of the past could suddenly turn aggressive, with no prior warning. Even if we had the computational horsepower, it would be pointless.
Ultimately, the investor or trader who forgets that they are making bets on future changes in the stock market and not on history is more naive, in my opinion, than one who admits that very little can be predicted. On the flipside, super-investors like Warren Buffett claim that paying attention to "intrinsic value" of a company and its stock, and ignoring the action of the market until it wakes up and realizing it was paying the wrong price, is the most effective means to make money. I have problems with that argument, too, but I'll address those another day.
There's a casino game called baccarat, one that isn't too often played but has a relatively small house edge (blackjack being one of the few that has a lower house edge). There are two sets of cards that come out for every round of the game, and although initially seeming complex, the play boils down to betting on which of those sets is higher or if they are equal. That's fine and dandy, but one of the things that casinos do is produce a baccarat scoresheet, which is essentially just a long rectangular grid of squares. Gamblers take that sheet and through their own systems, attempt to track the results of previous rounds and predict the results of future rounds. Since baccarat boils down to a sort of coin-toss, and anyone with a basic knowledge of odds knows that a series of coin tosses are completely independent (each toss has a 50% chance of being heads or tails), it's obvious that the only thing those meticulously recorded histories are doing is giving people the illusion of control. In fact, it's been proven mathematically that betting solely on the banker for every hand is the optimum baccarat strategy -- but people hate that, because... it's boring. So we discover the crux of gambling -- entertainment. This same urge is what drives investors and traders to develop theories that they feel might assist them. Essentially, they're all gamblers, but with longer timelines and more sophisticated systems.
One might argue that the stock market, being influenced by the actions of other players, means that paying attention to historical trends has a strong basis. After all, in poker games with players that you see consistently and learn to distinguish, knowing their previous play matters tremendously. Why doesn't the same apply to markets? Simple. Markets are composed of a group of people making decisions that are 1. too numerous to easily account for; 2. follow any infinite variety of systems; 3. interact with themselves (when people look at what the market is doing to determine what to do in the market -- they are the market). Computationally, even the idea of trying to model that behaviour is beyond our means. And still, in both cases, poker and the markets, we can only think about future actions as probability -- the passive, fish-like poker player of the past could suddenly turn aggressive, with no prior warning. Even if we had the computational horsepower, it would be pointless.
Ultimately, the investor or trader who forgets that they are making bets on future changes in the stock market and not on history is more naive, in my opinion, than one who admits that very little can be predicted. On the flipside, super-investors like Warren Buffett claim that paying attention to "intrinsic value" of a company and its stock, and ignoring the action of the market until it wakes up and realizing it was paying the wrong price, is the most effective means to make money. I have problems with that argument, too, but I'll address those another day.
Sunday, August 20, 2006
Fool's Paradise
I have a two-fold reason for starting this site: one, I'm tired of the America-centrism that exists in most investment blogs, since most of them are based in the United States. And two, I'm a natural cynic and anti-evangelist and I feel this perspective on investing is not as present as it should be online (or even in the real world). Everyone thinks that there's an effective system out there that just needs to be discovered, often through "technical" or "fundamental" means, as if these two terms can bring some form of empiricism to what at heart is a slowed-down form of intelligent gambling. The first trucks in colourful graphs and arbitrary rule-systems, while the second ascribes implicit value to companies, when value is solely the agreed upon price of a populace. Gold investors never seem to remember this, or fall back on the old "humans have always valued gold." Always? Really?
Anyhow, as you can plainly tell already, I'm not much of a believer. Why do I invest? For various reasons: a chance to make money, a gambling arena that has no real house edge, an intellectual pursuit with no real solution. Maybe it just tickles my fancy when the numbers go up -- entertainment? After a good seven years market-watching and reading and thinking about companies, I'm as willing to go with an experienced hunch and an adaptable attitude toward my investments (Rule No. 1, which I will continue to expound in the days ahead: Learn to Sell) as I am with some carefully calculated strategy that ultimately fails when some factor remains unaccounted for. It's busywork, and can only help you so far before you just have to open your eyes and survey the scene.
With that said, my intention here is not to recommend companies' stocks or educate the newbie investor. I will write about companies that I am thinking about and perhaps write about larger macroeconomic trends (although I'm not much of a macro-ist, frankly -- I think of investing in this way as much like burning down a forest to kill a tree. Hmm, think I'll need a better analogy than that!). I doubt I will describe my portfolio or its results, mainly because I think that if you do begin to do that, unless you are completely transparent about your results, that it is easy to become a shill for yourself -- letting people know your best trades, or just the percentage but not the sizing. It's natural for a lot of people to want to shine their shiniest shoes when they go out. I take the opposite tack, and usually obsess over my mistakes, but in either case, it's never an accurate reflection of a person's investing ability and tends to turn most investment blogs into de facto newsletters. So I will endeavour to be as objective as I can be and admit when I can't be.
I will also admit to not being an expert on any stock, even the ones that fall into my career of technology. No one can be, even many of the employees of the company. Everyone who buys and sells stocks curries to certain favourite elements of a stock, and neglects other parts, so while I don't have a complete and detailed view of GM, I do have an opinion on it and have acted on that opinion in the past -- I don't think anyone who really thinks about it can believe there are people who are experts on a stock. There are just people with more or less information, and in a strange twist, I think sometimes too much information can cause problems, too. There's a delicate balance there, one which makes me think that investing still falls closer to the realm of art, ultimately.
So, dear reader, watch this space!
Anyhow, as you can plainly tell already, I'm not much of a believer. Why do I invest? For various reasons: a chance to make money, a gambling arena that has no real house edge, an intellectual pursuit with no real solution. Maybe it just tickles my fancy when the numbers go up -- entertainment? After a good seven years market-watching and reading and thinking about companies, I'm as willing to go with an experienced hunch and an adaptable attitude toward my investments (Rule No. 1, which I will continue to expound in the days ahead: Learn to Sell) as I am with some carefully calculated strategy that ultimately fails when some factor remains unaccounted for. It's busywork, and can only help you so far before you just have to open your eyes and survey the scene.
With that said, my intention here is not to recommend companies' stocks or educate the newbie investor. I will write about companies that I am thinking about and perhaps write about larger macroeconomic trends (although I'm not much of a macro-ist, frankly -- I think of investing in this way as much like burning down a forest to kill a tree. Hmm, think I'll need a better analogy than that!). I doubt I will describe my portfolio or its results, mainly because I think that if you do begin to do that, unless you are completely transparent about your results, that it is easy to become a shill for yourself -- letting people know your best trades, or just the percentage but not the sizing. It's natural for a lot of people to want to shine their shiniest shoes when they go out. I take the opposite tack, and usually obsess over my mistakes, but in either case, it's never an accurate reflection of a person's investing ability and tends to turn most investment blogs into de facto newsletters. So I will endeavour to be as objective as I can be and admit when I can't be.
I will also admit to not being an expert on any stock, even the ones that fall into my career of technology. No one can be, even many of the employees of the company. Everyone who buys and sells stocks curries to certain favourite elements of a stock, and neglects other parts, so while I don't have a complete and detailed view of GM, I do have an opinion on it and have acted on that opinion in the past -- I don't think anyone who really thinks about it can believe there are people who are experts on a stock. There are just people with more or less information, and in a strange twist, I think sometimes too much information can cause problems, too. There's a delicate balance there, one which makes me think that investing still falls closer to the realm of art, ultimately.
So, dear reader, watch this space!
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