Books – October 2013

Nearly finished this on audio book:

    • The Quants: How a New Breed of Math Whizzes Conquered Wall Street and Nearly Destroyed It – Scott Patterson.


The muscular professor strode to the podium and faced yet another roomful of bright-eyed students eager to learn the secrets of how the stock market really worked. The professor, Eugene Fama, had been teaching at the University of Chicago since the early 1960s. Now, in September 1989, he was universally acknowledged as one of the brightest thinkers about financial markets and economics on the planet. Fama ran a hand across his balding head and squinted at the gangly sprawl of twenty somethings before him.

One trait about Fama that immediately jumped out to new students was his forehead. It was unusually large, high, and wide, traced with a stack of deep-cut lines that undulated like waves as he barked out wisdom about the markets in his Boston brogue as if agitated by the powerful thoughts percolating in his basketball-sized cranium. Clad in a loose-fitting blue cotton button-down shirt and tan chinos, he seemed more a refugee from the school’s philosophy department than a tough-minded guru of the money set.

His first words came as a shock to the students in the room. “Everything I’m about to say isn’t true,” said Fama in a gruff voice tinged with the accent of his Boston youth.

He walked to his chalkboard and wrote the following: Efficient-market hypothesis.

“The market is efficient,” Fama said. “What do I mean by that? It means that at any given moment, stock prices incorporate all known information about them. If lots of people are drinking Coca-Cola, its stock is going to go up as soon as that information is available.” Students scribbled on their notepads, taking it all in. The efficient-market hypothesis, perhaps the most famous and
long-lasting concept about how the market behaved in the past half century, was Fama’s baby. It had grown so influential, and had become so widely accepted, that it was less a hypothesis than a commandment from God in heaven passed down through his economic prophet of the Windy City. “There are a number of consequences to market efficiency,” Fama said, facing the classroom. “One of the most important is that it’s statistically impossible to know where the market is going next. This is known as the random walk theory, which means that the future course of the market is like a coin toss. It either goes up or down, fifty-fifty, no one knows which.”

A student near the front row raised a tentative hand.

“What about all the guys who get paid to pick stocks? They must get paid for a reason. It can’t be all luck.”

“The evidence shows that trying to pick stocks is a complete waste of time,” Fama said flatly. “And money. Wall Street is full of salesmen trying to convince people to give them a buck. But there’s never been a study in history showing active managers consistently beat the market. It’s just not in the data. Managers have good runs, but it usually does just come down to dumb luck.”

“Why do people pay these money managers so much money?” “Hope? Stupidity? It’s hard to say.” “What about Warren Buffett?” Fama sighed. That Buffett again. Increasingly, students were obsessed with the track record of this hick investor from Omaha, whose company, Berkshire Hathaway, had beaten the S&P 500 for two decades in a row and counting.

“There do seem to be a few outliers that are impossible to explain. In every science there are freaks that seem to defy all the rules. Buffett, as well as Peter Lynch at Fidelity’s Magellan fund, have had consistent returns over the years. I’m not aware of anyone else. These freak geniuses may be out there, but I don’t know who they are. Who knows,” he said with a shrug and a smile, “maybe they’ll lose it all next year.”

The math showed it was inevitable that a few traders would stand out, but that didn’t mean they had skill. Give ten thousand people a quarter. Tell them to flip. Each round, eliminate the ones who flipped heads. After ten rounds, maybe a hundred will be left. After twenty, maybe three or four will still be in the game. If they were on Wall Street, they’d be hailed as expert coin flippers, coin flippers drenched in alpha. Buffett, according to Fama, was in all probability a lucky coin flipper.

Another student raised a hand. “But you said everything you’re going to tell us isn’t true. So does that mean that markets really aren’t efficient?” “That’s right,” Fama said. “None of what I’m telling you is one hundred percent true. These are mathematical models. We look at statistics, historical data, trends, and extrapolate what we can from them. This isn’t physics. In physics, you can build the space shuttle, launch it into orbit, and watch it land at Cape Canaveral a week later. The market is far more unstable and unpredictable. What we know about it are approximations about reality based on models. The efficient-market hypothesis is just that, a hypothesis based on decades of research and a large amount of data. There’s always the chance we’re wrong.”

He paused. “Although I’m virtually certain that we’re right. God knows the market is efficient.”

The classroom laughed nervously.

  • New Frontiers in Technical Analysis: Effective Tools and Strategies for Trading and Investing – Paula Ciana.


A few interesting pages about market profile but not worth the price for the remainder.

  • How Markets Fail: The Logic of Economic Calamities – John Cassidy


Treading the fine line between biasing my thoughts and learning about the spectacular crashes of the past. A well written book about economists from Keynes to Minsky (still reading this one). He really does not believe in mutual funds.

  • Binge Trading: The Real Inside Story of Cash, Cocaine and Corruption in the City – Seth Freedman.


On my reading list:

  • 3 Steps to Investment Success – Rory Gillen.

I went to a conference ran by Gillen markets a few weeks ago. He seems like an honest guy and the show was better than the usual from vendors in this country. I read a small bit and his approach seems to be “you have to believe” (that the markets will go up) – a bit like Morpheus to Neo in The Matrix (and at odds with what Cassidy says above).


“Many believe that the stock markets are just for gamblers. It is certainly true that the stock markets can fulfil the gambling instincts in human nature, but the stock markets are first and foremost an investment forum. As an owner of shares (directly or through funds), you are a part-owner of businesses and, if they prosper, so too should you. In other words, returns accrue naturally to the owners of assets, but not so easily to the traders of assets.

“Many people are convinced that you have to predict which companies are the best to own, in order to make a success out of stock market investing. Nothing could be further from the truth.

Over the years, the question that I have consistently tried to answer is: how can the ordinary private investor succeed with limited time, little understanding of company accounts and no access to management? For that is the true test as to whether stock market investing is for everybody or just the knowledgeable few. Always bear in mind that it is the companies that produce the returns that the stock markets deliver, not the professional fund managers, not the speculators, not the media or individuals with inside information. It is the companies that generate the returns, and those returns reflect the growth in their profits, cash flows and dividends over time. You simply have to own a diversified list of them, either directly or through funds, to obtain those returns. Many private investors fail to do just that.

Stock markets can be a rollercoaster. Downturns bring volatility and uncertainty, which can impact on your confidence, judgement and desire to invest in a certain asset class. Bull markets do the opposite and bring over-confidence, tricking you into overlooking fundamental information. To maintain and grow your assets consistently, you need an approach that controls risk, reduces emotion, can be managed in a busy life and takes account of the significant volatility that is part and parcel of stock market investing.

There is no silver bullet for investment success and you can treat anyone who suggests otherwise with a healthy degree of scepticism. To achieve the average returns that the markets offer is easier than you may think; to achieve above-average returns is far more difficult than many appreciate.

…an understanding of why the markets tend to be so volatile, and an appreciation that volatility is not the same thing as risk. There is a major difference between temporary declines in prices and the risk of a permanent loss. Diversification, through funds or otherwise, an avoidance of leverage and a focus on value should allow you to ride out bear markets (down markets) and ensure that you recover with the markets, and hopefully more.

Like fundamental analysis, technical analysis demands study, patience and respect. However, if you take the time to understand the language of the market, you will free yourself from having to react to every move the market makes, or from being dependent on outside commentators interpretations of what is going on. What few understand is that it is not opinions in printed form that matter – the market is the opinion-former.”


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