"Liquid" is essentially synonymous with "popular" -- possibly why I'm sure there exist secretive, quant-run hedge funds that focus on using their models for liquid securities on the markets for illiquid versions (cf. Emanuel Derman). They can get a "fair value" and determine what kind of arbitrage exists in markets that are unpopular, where there are not enough people to guarantee that every instrument is fairly priced in an un-tradable time frame.
Starting to curry to Nassim Nicholas Taleb's writing again. I had skimmed his book something like six or eight months back but failed to appreciate how closely aligned his world view is with mine. Or the fact that so many other historical figures have come to the same conclusion: you can't predict the future using the past. It just occurred to me wonder what NNT thinks about Santayana: "Those who cannot remember the past are condemned to repeat it." Of course, history is never perfectly repeated, but we can develop lore and instinct from these past interactions, which is something I think NNT does agree with -- empirical (experiential) observations are where we should be looking. So I guess instead of simply "you can't predict the future using the past," we should add to that "but we can keep an eye on it." Predictability implies future knowledge and that is something we don't have, but certainly there are particular arrangements of preceding factors that may (BUT NOT DEFINITIVELY) give rise to similar future results.
I like quantitative finance for the admission that probability is a huge factor in markets, which is something completely missing from the "campfire story" tenets of "technical" trading. I do have to heed NNT's view that the Gaussian probability distribution probably is not the best way to understand a market that has numerous blow-ups (and if the Mandelbrotian fractal power law distribution or whatever is more applicable, what does that say about the size of some possible future blow-up? We ain't seen nothing yet...?). Is there any way to realistically account for these kinds of things? Taleb would buy huge numbers of OTM options (calls I think? Maybe both sides) with the idea that the view rare events that put him in the money were less rare than people thought, although it's not clear to me how that strategy worked out -- talk of that is conspicuously hard to find.
Saturday, November 04, 2006
Wednesday, October 11, 2006
'Fighting tomorrow's battles with yesterday's weapons."
A terrifically succinct overview of the year by one of my favourite business columnists, David Olive. Also the source of that pithy title.
Saturday, October 07, 2006
The accidental investor
An observant reader wrote in to point out the fact that, in my initial post on this site, I lamented the two analytical methodologies that most people chose to follow when trading in the stock market, but neglected to address what he felt was a third path -- that most lovingly tread by Burton Malkiel in A Random Walk Down Wall Street -- where any attempt at analysis would fail due to the randomness of the markets and the fact that at all times all available information is priced into the stock. Malkiel concluded that the investor in the stock market could not hope to beat the action of the markets themselves in the long run.
Now, the fact of the matter is that he could very well be right. For the investor who is not at all interested in finance or stock markets or researching companies or thinking about market trends and human and consumer psychology, then Malkiel gives a solid, if not infallible, argument for why that investor should stick their money in index funds and not worry too much about capturing the larger gains seen by more active investors (as well as the occasionally -- or often -- larger losses). But for those of us who are interested in those things, I think it's still quite possible to apply certain tenets of common sense, to imagine that an overheated market or a completely hated market might return to in a time of relative economic peace. True, in future economic and political turbulence could invalidate the stock markets as a real method of earning money (although it seems that perhaps those times are often the best to make money, too! Turbulence does not affect all areas equally, much like that William Gibson quote: "The future is here, it's just not evenly distributed."
Some of the things that are common sense, at least to me, are:
1. Companies that have earnings, and particularly those that have records of earnings for a number of years, are usually better investments in the long run than growth companies -- trying to guess which growth company will be able to transition to an earnings company is much closer to gambling than choosing companies that have already made that transition.
2. Things that have been popular for a long time are closer to being unpopular than things that are only recently starting to get popular, due to people's love of novelty. This is a way of finding "growth" in a company that may already be an earnings company.
3. Valuation is arbitrary, depending on your perspective, but cheapness can still be measured against what people have paid in the past. That said, buying anything cheaply is no guarantee that it'll retain its value.
4. Your lifetime (or your investing horizon) may not be "a long time", even if you think it is.
As you can see, there's enough qualification in there, which is part and parcel of my philosophy that you should never assume you know what you're doing. You can be 99% sure of something, but that margin of error should never be forgotten when investing. Doubt, but just enough.
I should also clarify for my readers that in my previous post I was saying that I was not interested in investing in oil -- a reader of mine assumed that I was pointing out a dissimilarity between the energy boom and the Internet stock boom in that the former was supposedly based on educated speculation whereas the latter was not. I don't buy that, but I won't say I'm negative on oil, just that I'm not interested in it, or its obvious volatility. As well, I'm starting to think telecom and particularly companies in the VoIP arena are getting a bit of that hype machine action that pushed energy. There's still something there that's making my spidey sense tingle.
Now, the fact of the matter is that he could very well be right. For the investor who is not at all interested in finance or stock markets or researching companies or thinking about market trends and human and consumer psychology, then Malkiel gives a solid, if not infallible, argument for why that investor should stick their money in index funds and not worry too much about capturing the larger gains seen by more active investors (as well as the occasionally -- or often -- larger losses). But for those of us who are interested in those things, I think it's still quite possible to apply certain tenets of common sense, to imagine that an overheated market or a completely hated market might return to in a time of relative economic peace. True, in future economic and political turbulence could invalidate the stock markets as a real method of earning money (although it seems that perhaps those times are often the best to make money, too! Turbulence does not affect all areas equally, much like that William Gibson quote: "The future is here, it's just not evenly distributed."
Some of the things that are common sense, at least to me, are:
1. Companies that have earnings, and particularly those that have records of earnings for a number of years, are usually better investments in the long run than growth companies -- trying to guess which growth company will be able to transition to an earnings company is much closer to gambling than choosing companies that have already made that transition.
2. Things that have been popular for a long time are closer to being unpopular than things that are only recently starting to get popular, due to people's love of novelty. This is a way of finding "growth" in a company that may already be an earnings company.
3. Valuation is arbitrary, depending on your perspective, but cheapness can still be measured against what people have paid in the past. That said, buying anything cheaply is no guarantee that it'll retain its value.
4. Your lifetime (or your investing horizon) may not be "a long time", even if you think it is.
As you can see, there's enough qualification in there, which is part and parcel of my philosophy that you should never assume you know what you're doing. You can be 99% sure of something, but that margin of error should never be forgotten when investing. Doubt, but just enough.
I should also clarify for my readers that in my previous post I was saying that I was not interested in investing in oil -- a reader of mine assumed that I was pointing out a dissimilarity between the energy boom and the Internet stock boom in that the former was supposedly based on educated speculation whereas the latter was not. I don't buy that, but I won't say I'm negative on oil, just that I'm not interested in it, or its obvious volatility. As well, I'm starting to think telecom and particularly companies in the VoIP arena are getting a bit of that hype machine action that pushed energy. There's still something there that's making my spidey sense tingle.
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