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Certainly you need to protect against over fitting your models, and you need to consider tail events. But to say that the entire market is fully random is to c

Certainly you need to protect against over fitting your models, and you need to consider tail events. But to say that the entire market is fully random is to claim that the efficient market hypothesis holds, which it clearly doesn't - not even in weak form. Anyone who wants to claim that the EMH is true needs to explain the equity premium puzzle, the success of value investing and the persistent outperformance of momentum investing - among many other price anomalies that I could name.

lutusp 14y ago
> But to say that the entire market is fully random is to claim that the efficient market hypothesis holds, which it clearly doesn't - not even in weak form. Of course it does. All evidence supports the Efficient Market Hypothesis (EMH), and note my use of the word "evidence". A contradiction would have to be a series of funds that applied a given, predefined (internally) strategy and (very important) didn't reveal its picks to the public (to avoid the announcement effect). Such an experiment hasn't been done, and those cases in which a specific strategy was applied have been universal failures. Let's say for the sake of argument that there is a surefire winning strategy as is so often claimed in worthless investment books. If it were to be recognized and then applied, it would become the new market norm, everyone would apply it, and its differential value would evaporate overnight. That hypothetical experiment merely supports the EMH. > Anyone who wants to claim that the EMH is true needs to explain the equity premium puzzle, the success of value investing and the persistent outperformance of momentum investing - among many other price anomalies that I could name. Those result from a combination of the announcement effect and insider trading. Berkshire-Hathaway is successful because people expect it to be successful, and who invest in the same stocks when they're announced. It's a self-fulfilling prophecy. The only fair, scientific test would be a strategy that is applied in secret, not in public like Berkshire-Hathaway, and in a way that doesn't tweak the market itself by way of large purchases that create their own following of fanboys. In other words, a pure computer model that is defined in advance, not tweaked enroute, that doesn't actually invest but only models hypothetical investments, and that shows its value over other systems in perpetuity. There is no such thing, and the EMH is true. Remember the Null Hypothesis, the basis of modern scientific thinking. The Null Hypothesis assumes something without evidence is false. All evidence supports the EMH.
- yarou 14y ago
  Only in academic circles does EMH stay true. Time and time again, reality has shown that EMH is not applicable, or exists in a very weak form. One need only look to the LBO bubble and the dotcom bubble to see counter-examples of EMH.
  - lutusp 14y ago
    In a conversation like this, rhetoric is cheap, and there is no evidence for your position. All evidence suggests that the EMH is true. Prove this wrong -- identify a surefire winning stock picking strategy that is immune to the announcement effect and insider trading, that reliably puts its practitioners ahead of market indices. There is no such thing. > One need only look to the LBO bubble and the dotcom bubble to see counter-examples of EMH. Those are not counterexamples, and they bear no relevance to the present topic. Anyone can misbehave in spectacular ways, but those misbehaviors don't falsify the EMH, any more than an airplane crash falsifies theories of aerodynamics.
    - lolcraft 14y ago
      First, from Wikipedia: "Empirical analyses have consistently found problems with the efficient-market hypothesis, the most consistent being that stocks with low price to earnings (and similarly, low price to cash-flow or book value) outperform other stocks." At the very least, accept that it's not such a clear case as you present it to be. But then, what about HFT arbitrage, low P/E ratios, choosing underperforming companies to take advantage of regression to the mean, Piotroski's F-Score, Graham-style value investing, bait and switch dumping, swing trading, the very real problem of pricing goodwill and non-material resources...? If not undermining weak EMH, at least they cast doubts over the strong forms. Or they should. Do also read John Carter's Mastering the Trade for some examples on how market inefficiencies can be exploited reliably. Supposedly (seen in Wikipedia, so I'm not that confident) market crashes are interpreted to be impossible under strong EMH (and yeah, the bubbles would definitely falsify them), but are allowed in weak EMH to be statistical events of a random process. Now, I've heard an interesting and convincing argument by Steve Keen[1] that the market is not Gaussian noise; it's a fractal process with dimension ~ 1.7 (Gaussian's dimension is 2) whose crashes obey a power law distribution, very different from what a random walk would generate. That falsifies the weak form. > Prove this wrong -- identify a surefire winning stock picking strategy that is immune to the announcement effect and insider trading, that reliably puts its practitioners ahead of market indices. Falsifying EMH does not require such a thing, no more than proving relativity requires observing time dilation at all velocities. This is an onerous, diabolical burden of proof. > Anyone can misbehave in spectacular ways, but those misbehaviors don't falsify the EMH, any more than an airplane crash falsifies theories of aerodynamics. If you had periodic epidemics of plane crashes that were more frequent than expected, sure, you should definitely suspect something's wrong. [1] Yeah, some things he says are somewhat crackpotty, but he's definitely not to be completely dismissed beforehand. I refer to his Behavioural Finance Lectures, published in Youtube.
scotty79 14y ago
Overfitting your models? If you fail to predict an earthquake or a tornado do you blame it on overfitting your model? I don't think so. You just humbly say that you don't have good enough model, enough computing power, and what's most important not enough data. Value investing is just buying things that you think are under-priced. It's successful if you are right and you are faster then other people to notice that, or you are actually wrong but lots of people also make same mistake but later than you. Or if you are Warren Buffet then other people think you must be right and buy the same thing making you even more rich. As for momentum investing it's easy to just read wikipedia entry on that. It's not even established that this effect exists and even if so it's offset by additional risk undertaken by adhering to this rigid strategy. I'm not sure how Equity premium puzzle even relates to efficient market hypothesis. People clearly don't believe that efficient market hypothesis holds but same can be said about any recurring lottery. People keep inventing systems for picking lottery numbers, and claim that some of them work for some of them for some time. Which they do, until they don't. If efficient market hypothesis doesn't hold, how do you explain this: http://finance.fortune.cnn.com/2013/01/24/buffett-hedge-fund-bet/ http://finance.fortune.cnn.com/2013/01/24/buffett-hedge-fund... ? When you are investing you don't play against the environment. In fact environment is favorable to you. You just compete with other players to rip off other players. It's so full of chaotic feedbacks that you can't predict anything. I mean, you can, until you can't. It's just like gambling. You can always win at fair gambling, just bet more if you loose. You'll be winning until you loose so many times in a row that you loose everything.

lutusp 14y ago

> But to say that the entire market is fully random is to claim that the efficient market hypothesis holds, which it clearly doesn't - not even in weak form. Of course it does. All evidence supports the Efficient Market Hypothesis (EMH), and note my use of the word "evidence". A contradiction would have to be a series of funds that applied a given, predefined (internally) strategy and (very important) didn't reveal its picks to the public (to avoid the announcement effect). Such an experiment hasn't been done, and those cases in which a specific strategy was applied have been universal failures. Let's say for the sake of argument that there is a surefire winning strategy as is so often claimed in worthless investment books. If it were to be recognized and then applied, it would become the new market norm, everyone would apply it, and its differential value would evaporate overnight. That hypothetical experiment merely supports the EMH. > Anyone who wants to claim that the EMH is true needs to explain the equity premium puzzle, the success of value investing and the persistent outperformance of momentum investing - among many other price anomalies that I could name. Those result from a combination of the announcement effect and insider trading. Berkshire-Hathaway is successful because people expect it to be successful, and who invest in the same stocks when they're announced. It's a self-fulfilling prophecy. The only fair, scientific test would be a strategy that is applied in secret, not in public like Berkshire-Hathaway, and in a way that doesn't tweak the market itself by way of large purchases that create their own following of fanboys. In other words, a pure computer model that is defined in advance, not tweaked enroute, that doesn't actually invest but only models hypothetical investments, and that shows its value over other systems in perpetuity. There is no such thing, and the EMH is true. Remember the Null Hypothesis, the basis of modern scientific thinking. The Null Hypothesis assumes something without evidence is false. All evidence supports the EMH.

yarou 14y ago
Only in academic circles does EMH stay true. Time and time again, reality has shown that EMH is not applicable, or exists in a very weak form. One need only look to the LBO bubble and the dotcom bubble to see counter-examples of EMH.
- lutusp 14y ago
  In a conversation like this, rhetoric is cheap, and there is no evidence for your position. All evidence suggests that the EMH is true. Prove this wrong -- identify a surefire winning stock picking strategy that is immune to the announcement effect and insider trading, that reliably puts its practitioners ahead of market indices. There is no such thing. > One need only look to the LBO bubble and the dotcom bubble to see counter-examples of EMH. Those are not counterexamples, and they bear no relevance to the present topic. Anyone can misbehave in spectacular ways, but those misbehaviors don't falsify the EMH, any more than an airplane crash falsifies theories of aerodynamics.
  - lolcraft 14y ago
    First, from Wikipedia: "Empirical analyses have consistently found problems with the efficient-market hypothesis, the most consistent being that stocks with low price to earnings (and similarly, low price to cash-flow or book value) outperform other stocks." At the very least, accept that it's not such a clear case as you present it to be. But then, what about HFT arbitrage, low P/E ratios, choosing underperforming companies to take advantage of regression to the mean, Piotroski's F-Score, Graham-style value investing, bait and switch dumping, swing trading, the very real problem of pricing goodwill and non-material resources...? If not undermining weak EMH, at least they cast doubts over the strong forms. Or they should. Do also read John Carter's Mastering the Trade for some examples on how market inefficiencies can be exploited reliably. Supposedly (seen in Wikipedia, so I'm not that confident) market crashes are interpreted to be impossible under strong EMH (and yeah, the bubbles would definitely falsify them), but are allowed in weak EMH to be statistical events of a random process. Now, I've heard an interesting and convincing argument by Steve Keen[1] that the market is not Gaussian noise; it's a fractal process with dimension ~ 1.7 (Gaussian's dimension is 2) whose crashes obey a power law distribution, very different from what a random walk would generate. That falsifies the weak form. > Prove this wrong -- identify a surefire winning stock picking strategy that is immune to the announcement effect and insider trading, that reliably puts its practitioners ahead of market indices. Falsifying EMH does not require such a thing, no more than proving relativity requires observing time dilation at all velocities. This is an onerous, diabolical burden of proof. > Anyone can misbehave in spectacular ways, but those misbehaviors don't falsify the EMH, any more than an airplane crash falsifies theories of aerodynamics. If you had periodic epidemics of plane crashes that were more frequent than expected, sure, you should definitely suspect something's wrong. [1] Yeah, some things he says are somewhat crackpotty, but he's definitely not to be completely dismissed beforehand. I refer to his Behavioural Finance Lectures, published in Youtube.

scotty79 14y ago

Overfitting your models? If you fail to predict an earthquake or a tornado do you blame it on overfitting your model? I don't think so. You just humbly say that you don't have good enough model, enough computing power, and what's most important not enough data. Value investing is just buying things that you think are under-priced. It's successful if you are right and you are faster then other people to notice that, or you are actually wrong but lots of people also make same mistake but later than you. Or if you are Warren Buffet then other people think you must be right and buy the same thing making you even more rich. As for momentum investing it's easy to just read wikipedia entry on that. It's not even established that this effect exists and even if so it's offset by additional risk undertaken by adhering to this rigid strategy. I'm not sure how Equity premium puzzle even relates to efficient market hypothesis. People clearly don't believe that efficient market hypothesis holds but same can be said about any recurring lottery. People keep inventing systems for picking lottery numbers, and claim that some of them work for some of them for some time. Which they do, until they don't. If efficient market hypothesis doesn't hold, how do you explain this: http://finance.fortune.cnn.com/2013/01/24/buffett-hedge-fund-bet/ http://finance.fortune.cnn.com/2013/01/24/buffett-hedge-fund... ? When you are investing you don't play against the environment. In fact environment is favorable to you. You just compete with other players to rip off other players. It's so full of chaotic feedbacks that you can't predict anything. I mean, you can, until you can't. It's just like gambling. You can always win at fair gambling, just bet more if you loose. You'll be winning until you loose so many times in a row that you loose everything.