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"Even professional investors, who devote their lives to following the market, only occasionally beat the market." There are lots of investors and traders/specu

by hsitz 13y ago

"Even professional investors, who devote their lives to following the market, only occasionally beat the market." There are lots of investors and traders/speculators who beat the market. I think this is one of the main reasons people persist in trading despite reading articles/posts like the one of this thread. The key thing these people don't understand, though, is that the number of investors who do beat the market (at any given level of outperformance) is no greater than what is predicted by investment decisions governed solely by chance. In other words, there is no or at least very little evidence that the people who beat the market do so by making use of _skill_ (there is some evidence that skilled investors can expect to outperform the market by a percentage point or so per annum, i.e., small outperformance and few of these "skilled" investors). The statistical analysis of the performance of investors over last half century and more is basis of so-called "efficient market theory" (EMT), which most misunderstand. EMT does not say that investors can't outperform the market. This is obviously false, since many do. EMT says basically that investors should not expect to be able to use skill to outperform market; if they in fact outperform it is the result of chance, and there was equal chance of underperforming the market. I'm always amused at the number of people who read about EMT and discard it as "obviously false". Do they really think that high-powered intellects have been analyzing this stuff for decades and come up with something that can be rejected by a man-on-the-street as "obviously false"? Hmm, perhaps the man-on-the-street is misunderstanding what they're saying. Two good sources to start with are Malkiel's classic _A Random Walk Down Wall Street_, and William Bernstein's dependable investing guide _The Four Pillars of Investing_.

rdtsc 13y ago
> at least very little evidence that the people who beat the market do so by making use of _skill_ Also there is a strong selection bias component. People who lose don't usually brag to their friends/news station/co-workers/blogs/twitter, those that beat the market do. This is the same as lottery. If you had to sit and watch a 1 min clip of everyone who bought a ticket and didn't win, just like people watch those that played and won. Nobody would probably buy lottery tickets. But because of the selection bias, it seems there is always so and so how "made lots of money on the stock market, so why can't you?"
brc 13y ago
There are plenty of professional investors who have beaten the market year after year, and by a lot more than single digit percentages. Multi-decade returns of 20% and above are well documented. I personally invested in a fund 12 years ago which has returned a compound 21% pa return over that period, so I know that they definitely exist. The chance of this happening due to luck is impossibly low. Some professionals have an edge by developing a model of the market that suits their particular risk levels/cognitive model. As long as that edge continues to work, they continue to outperform by large amounts. The edge might be extraordinary discipline, it might be a allocation size model, it might be a risk-management model. The edge has to exist, and most importantly, it has to match the psychological profile of the individual. The mistake is not that the EMT is particularly true, it is that amateurs approach the markets with the hope of replicating the results of the professionals, and that amateurs think they have an edge, but they in reality do not. If the Efficient Markets Theory is to hold true, then in no case should people have multi-year returns well in excess of average. Since this is true, then most people will say that the theory is false. I don't really have a dog in the fight- I don't care either way. But I don't think you can say that it is chance that causes people outperform the market, because there is far too much evidence to the contrary. As for the 'people studied for years' bit - I don't think that strengthens any argument. The research world is littered with theories that have failed, and length of time spent researching has little correlation with factual correctness. Ultimately, more theories have to fail than succeed in order for knowledge to be gained.
- yardie 13y ago
  The only professional investor I am aware of returning 20%pa was Bernie Madhoff, and we all know how that turned out.
  - loganfrederick 13y ago
    http://en.wikipedia.org/wiki/James_Harris_Simons#Business_career http://en.wikipedia.org/wiki/James_Harris_Simons#Business_ca...
  - clarky07 13y ago
    Perhaps you should look into Warren Buffett. I hear he's pretty good too. Peter Lynch was alright as well.
grey-area 13y ago
Isn't it normally referred to as the efficient market hypothesis? You don't have to think investors can consistently beat the market to distrust that hypothesis, and plenty of economists think it is suspect, e.g. behavioural economists: http://www.economist.com/blogs/freeexchange/2009/08/behavioural_finance_to_the_res http://www.economist.com/blogs/freeexchange/2009/08/behaviou... A belief in an efficient market is far from a consensus among professionals. I personally think it's pretty absurd to claim that markets are efficient given that their behaviour is driven by humans with a lot to gain/lose, and algorithms which are looking for short-term profit, not efficiency, and also given the many acknowledged examples of over-confidence, corruption, bubbles and subsequent crashes over the last few decades.
- hsitz 13y ago
  The EMT (or EMH) is obviously false in its strongest form. However in a weaker form it is generally accepted even by behavioral finance guys. That is, even many (most?) behavioral finance economists believe market is efficient enough that investors should not expect to outperform the market. Can read a little more and get specific example of behavioral finance guru Daniel Kahneman on this point in Wikipedia article here: http://en.wikipedia.org/wiki/Efficient-market_hypothesis http://en.wikipedia.org/wiki/Efficient-market_hypothesis
d23 13y ago
> Do they really think that high-powered intellects have been analyzing this stuff for decades and come up with something that can be rejected by a man-on-the-street as "obviously false"? Yes, because they're idiots. Idiots can feel in their gut truth and no amount of "facts" or logical reasoning can dissuade them.

by hsitz 13y ago

rdtsc 13y ago

> at least very little evidence that the people who beat the market do so by making use of _skill_ Also there is a strong selection bias component. People who lose don't usually brag to their friends/news station/co-workers/blogs/twitter, those that beat the market do. This is the same as lottery. If you had to sit and watch a 1 min clip of everyone who bought a ticket and didn't win, just like people watch those that played and won. Nobody would probably buy lottery tickets. But because of the selection bias, it seems there is always so and so how "made lots of money on the stock market, so why can't you?"

brc 13y ago

There are plenty of professional investors who have beaten the market year after year, and by a lot more than single digit percentages. Multi-decade returns of 20% and above are well documented. I personally invested in a fund 12 years ago which has returned a compound 21% pa return over that period, so I know that they definitely exist. The chance of this happening due to luck is impossibly low. Some professionals have an edge by developing a model of the market that suits their particular risk levels/cognitive model. As long as that edge continues to work, they continue to outperform by large amounts. The edge might be extraordinary discipline, it might be a allocation size model, it might be a risk-management model. The edge has to exist, and most importantly, it has to match the psychological profile of the individual. The mistake is not that the EMT is particularly true, it is that amateurs approach the markets with the hope of replicating the results of the professionals, and that amateurs think they have an edge, but they in reality do not. If the Efficient Markets Theory is to hold true, then in no case should people have multi-year returns well in excess of average. Since this is true, then most people will say that the theory is false. I don't really have a dog in the fight- I don't care either way. But I don't think you can say that it is chance that causes people outperform the market, because there is far too much evidence to the contrary. As for the 'people studied for years' bit - I don't think that strengthens any argument. The research world is littered with theories that have failed, and length of time spent researching has little correlation with factual correctness. Ultimately, more theories have to fail than succeed in order for knowledge to be gained.

yardie 13y ago
The only professional investor I am aware of returning 20%pa was Bernie Madhoff, and we all know how that turned out.
- loganfrederick 13y ago
  http://en.wikipedia.org/wiki/James_Harris_Simons#Business_career http://en.wikipedia.org/wiki/James_Harris_Simons#Business_ca...
- clarky07 13y ago
  Perhaps you should look into Warren Buffett. I hear he's pretty good too. Peter Lynch was alright as well.

grey-area 13y ago

Isn't it normally referred to as the efficient market hypothesis? You don't have to think investors can consistently beat the market to distrust that hypothesis, and plenty of economists think it is suspect, e.g. behavioural economists: http://www.economist.com/blogs/freeexchange/2009/08/behavioural_finance_to_the_res http://www.economist.com/blogs/freeexchange/2009/08/behaviou... A belief in an efficient market is far from a consensus among professionals. I personally think it's pretty absurd to claim that markets are efficient given that their behaviour is driven by humans with a lot to gain/lose, and algorithms which are looking for short-term profit, not efficiency, and also given the many acknowledged examples of over-confidence, corruption, bubbles and subsequent crashes over the last few decades.

hsitz 13y ago
The EMT (or EMH) is obviously false in its strongest form. However in a weaker form it is generally accepted even by behavioral finance guys. That is, even many (most?) behavioral finance economists believe market is efficient enough that investors should not expect to outperform the market. Can read a little more and get specific example of behavioral finance guru Daniel Kahneman on this point in Wikipedia article here: http://en.wikipedia.org/wiki/Efficient-market_hypothesis http://en.wikipedia.org/wiki/Efficient-market_hypothesis

d23 13y ago

> Do they really think that high-powered intellects have been analyzing this stuff for decades and come up with something that can be rejected by a man-on-the-street as "obviously false"? Yes, because they're idiots. Idiots can feel in their gut truth and no amount of "facts" or logical reasoning can dissuade them.