Shorting stocks.
November 7, 2005 11:39 AM Subscribe
Stock market filter: Long vs. short.
Considering that amateur investors often lose money in the stock market, would the outcome be reversed if an amateur shorted instead? Is it easier to pick losers than winners? What are the signs of a good short pick? What are the pitfalls of shorting?
Considering that amateur investors often lose money in the stock market, would the outcome be reversed if an amateur shorted instead? Is it easier to pick losers than winners? What are the signs of a good short pick? What are the pitfalls of shorting?
The biggest pitfall of shorting, as I understand it, is that your potential losses are not limited by your initial investment: theoretically, the stock could just keep going up and up, and your losses would keep going up and up.
posted by schustafa at 11:45 AM on November 7, 2005
posted by schustafa at 11:45 AM on November 7, 2005
Historically the stock market has provided a good long-term return on investment.
The reasons some amateur investors lose money are a) over the short term the stock market has frequent down turns and b) the fees incurred by frequent trades.
Shorting is a stock would be a worse strategy than buying a random stock.
posted by justkevin at 12:10 PM on November 7, 2005
The reasons some amateur investors lose money are a) over the short term the stock market has frequent down turns and b) the fees incurred by frequent trades.
Shorting is a stock would be a worse strategy than buying a random stock.
posted by justkevin at 12:10 PM on November 7, 2005
Correction: Shorting a random stock would be a worse strategy than buying a random stock
posted by justkevin at 12:11 PM on November 7, 2005
posted by justkevin at 12:11 PM on November 7, 2005
Also...shorting stocks as an individual investor is terribly uneconomic. Individuals are typically required to post a 100% cash margin versus the short (meaning the proceeds from the short sale are not available for other transactions). Institutions can short a security and use the proceeds to invest elsewhere as a countertrade to the short. The margin serves as protection for brokerage firm if the shorted security goes up in price...if the stock goes up enough, you may be asked to post additional margin. If your research or knowledge about a specific situation makes you very comfortable that a security is headed south, shorting can be an entertaining way to play in the stock market but it is not for the unsophisticated or faint-of-heart.
posted by cyclopz at 12:34 PM on November 7, 2005
posted by cyclopz at 12:34 PM on November 7, 2005
I've heard it said that most successful traders rarely use short positions by themselves, more usually they're done as part of a pair trade or a hedge.
It would be at least slightly more rational to try and have as little bias as possible to one side or the other. Aiming to be exclusively short all the time seems like a really extremely bad idea, in general.
posted by sfenders at 12:40 PM on November 7, 2005
It would be at least slightly more rational to try and have as little bias as possible to one side or the other. Aiming to be exclusively short all the time seems like a really extremely bad idea, in general.
posted by sfenders at 12:40 PM on November 7, 2005
What are the signs of a good short pick?
Note for example that GOOG has been showing all the signs of a good short pick for a while now (highly over-valued by fundamentals, all the technicals at overbought extremes), yet it just keeps on going UP. It seems like it's much more common for an over-priced stock to get more over-priced than it is for an undervalued one to get cheaper.
posted by sfenders at 12:44 PM on November 7, 2005
Note for example that GOOG has been showing all the signs of a good short pick for a while now (highly over-valued by fundamentals, all the technicals at overbought extremes), yet it just keeps on going UP. It seems like it's much more common for an over-priced stock to get more over-priced than it is for an undervalued one to get cheaper.
posted by sfenders at 12:44 PM on November 7, 2005
DON'T SHORT unless you know what you're doing. Typically, anyway, a brokerage will require you to have liquid assets (usually cash) on-hand to cover the spread when the call comes in. If you buy a stock at $10, and it drops to $0, you've lost your investment and that's it. If you short a stock at $10, and it goes up to $20, you've lost 2x your investment, and there's still the possibility to lose more.
The reason most amateurs don't make money is because they don't know when to sell, not because they invest in stocks that are necessarily bad.
posted by mkultra at 1:39 PM on November 7, 2005
The reason most amateurs don't make money is because they don't know when to sell, not because they invest in stocks that are necessarily bad.
posted by mkultra at 1:39 PM on November 7, 2005
Your misunderstanding lies within your first question. Under the EMH, amateurs don't underperform the market because they pick bad stocks; they underperform the market because of commissions.
The odd-lot theory (a logical extension of the fact you presuppose) has been largely discredited.
posted by Kwantsar at 1:45 PM on November 7, 2005
The odd-lot theory (a logical extension of the fact you presuppose) has been largely discredited.
posted by Kwantsar at 1:45 PM on November 7, 2005
Also, if you want to be contrary, but are afraid of losing too much money, buy puts.
posted by Kwantsar at 1:47 PM on November 7, 2005
posted by Kwantsar at 1:47 PM on November 7, 2005
The class of investments of which "shorting" is a particular instance is often referred to as buying or selling "on margin."
You're not buying a share; you're buying the chance (the "option") to purchase or sell a share at a given price at some future date. Because the market-set price of these options is "derived" from what market makers think the share price is going to be on the date in question, these are often called "derivatives."
Buying a share of stock implies that you think you're smarter than the market with regard to a company's growth and future value. Since the US economy has been strong, buying stocks has historically been a good long-term bet.
Buying a derivative implies that you think you're smarter, in a defined short-term, than a market maker who makes his living on derivatives; a company or economy's long-term growth potential is factored out of the equation. And, depending on how stupidly you endorse this belief, the amount of money you can lose is nearly unlimited.
posted by ikkyu2 at 1:51 PM on November 7, 2005
You're not buying a share; you're buying the chance (the "option") to purchase or sell a share at a given price at some future date. Because the market-set price of these options is "derived" from what market makers think the share price is going to be on the date in question, these are often called "derivatives."
Buying a share of stock implies that you think you're smarter than the market with regard to a company's growth and future value. Since the US economy has been strong, buying stocks has historically been a good long-term bet.
Buying a derivative implies that you think you're smarter, in a defined short-term, than a market maker who makes his living on derivatives; a company or economy's long-term growth potential is factored out of the equation. And, depending on how stupidly you endorse this belief, the amount of money you can lose is nearly unlimited.
posted by ikkyu2 at 1:51 PM on November 7, 2005
ikkyu2: "you're buying the chance (the "option") to purchase or sell a share"
No, that would be an "option". Selling short is not much like that, and I don't even think it's usually counted as a "derivative". It's a real sale of the actual stock, plus an obligation (not an option) to cover it later. Also, derivatives in general, and equity options in particular, have pretty much nothing to do with margin.
Kwantsar: "if you want to be contrary, but are afraid of losing too much money, buy puts."
Seems to me that buying puts is not much more safe than selling short. Sure, you can't lose more money than you started with. But options have some extra complications that don't make it any easier to make a profit. Trading options is probably not such a good idea for someone who isn't comfortable with plain old stocks.
posted by sfenders at 2:32 PM on November 7, 2005
No, that would be an "option". Selling short is not much like that, and I don't even think it's usually counted as a "derivative". It's a real sale of the actual stock, plus an obligation (not an option) to cover it later. Also, derivatives in general, and equity options in particular, have pretty much nothing to do with margin.
Kwantsar: "if you want to be contrary, but are afraid of losing too much money, buy puts."
Seems to me that buying puts is not much more safe than selling short. Sure, you can't lose more money than you started with. But options have some extra complications that don't make it any easier to make a profit. Trading options is probably not such a good idea for someone who isn't comfortable with plain old stocks.
posted by sfenders at 2:32 PM on November 7, 2005
In addition to brokerage restrictions, it's harder to make money short than long, because to make money long you only have to be right once, on the fundamental call. To make money on a naked short you have to be right both on the fundamentals and the timing.
The need to constantly monitor a short position is also a huge hidden cost. You can go long and devote minimal time to monitoring a position. A short hangs over your head from the moment you sell to the moment you cover, reducing your time to find the next play.
Hypothetically -- and this won't be good advice for the vast majority of people -- a way to get a feel for bearish investing is to set aside a small portion of your portfolio to buy puts and sell puts you've bought (not writing new puts, which is just another way to be short, albeit bullishly short). If you're actually up on that portion of your account after six months, maybe you've got the skills to consider shorting stocks.
posted by MattD at 2:34 PM on November 7, 2005
The need to constantly monitor a short position is also a huge hidden cost. You can go long and devote minimal time to monitoring a position. A short hangs over your head from the moment you sell to the moment you cover, reducing your time to find the next play.
Hypothetically -- and this won't be good advice for the vast majority of people -- a way to get a feel for bearish investing is to set aside a small portion of your portfolio to buy puts and sell puts you've bought (not writing new puts, which is just another way to be short, albeit bullishly short). If you're actually up on that portion of your account after six months, maybe you've got the skills to consider shorting stocks.
posted by MattD at 2:34 PM on November 7, 2005
mkultra wrote: If you buy a stock at $10, and it drops to $0, you've lost your investment and that's it. If you short a stock at $10, and it goes up to $20, you've lost 2x your investment.
No. Both trades result in a loss of $10. Also, both trades can be made with a $5 investment (using margin). Comparing loss percentages is misleading when the short position is leveraged and the long position is not. You have to assume the long position is also bought on margin.
BTW, these small leveraged positions also incur interest at 8.99%. Larger margin debts get better rates. There are 1% discounts at 50k, 250k, and 1M.
Links to E*Trade's online help:
* Sell short and buy to cover orders.
* Trade on margin.
* Margin maintenance requirements.
* Margin interest rates.
posted by ryanrs at 3:19 PM on November 7, 2005
No. Both trades result in a loss of $10. Also, both trades can be made with a $5 investment (using margin). Comparing loss percentages is misleading when the short position is leveraged and the long position is not. You have to assume the long position is also bought on margin.
BTW, these small leveraged positions also incur interest at 8.99%. Larger margin debts get better rates. There are 1% discounts at 50k, 250k, and 1M.
Links to E*Trade's online help:
* Sell short and buy to cover orders.
* Trade on margin.
* Margin maintenance requirements.
* Margin interest rates.
posted by ryanrs at 3:19 PM on November 7, 2005
I forget who said this, but: "The market can stay irrational longer than you can stay solvent."
Also, getting back to your original question:
"Considering that amateur investors often lose money in the stock market, would the outcome be reversed if an amateur shorted instead?"
The way you've worded that suggests you think that our hypothetical amateur would pick the same stocks, but go short instead of long. But why would they? In fact though, assuming that stock-picking is a valid strategy at all (the EMH people think it isn't), amateurs would be just as bad a picking stocks to short as they are at picking long positions.
Amateurs at anything lose because they lack the skill and time to do as well as a professional. (Note that professionals on average underperform the index, even if they don't lose that much, which is not encouraging).
Finally, in the Graham sense - an investment is something that promises a return and safety of capital - shorting is not really an investment strategy on its own, since it does not provide safety of capital. Perhaps combined with another strategy it might be part of an overall investment. An investor, strictly defined, would not short as an activity in its own right.
posted by i_am_joe's_spleen at 3:30 PM on November 7, 2005
Also, getting back to your original question:
"Considering that amateur investors often lose money in the stock market, would the outcome be reversed if an amateur shorted instead?"
The way you've worded that suggests you think that our hypothetical amateur would pick the same stocks, but go short instead of long. But why would they? In fact though, assuming that stock-picking is a valid strategy at all (the EMH people think it isn't), amateurs would be just as bad a picking stocks to short as they are at picking long positions.
Amateurs at anything lose because they lack the skill and time to do as well as a professional. (Note that professionals on average underperform the index, even if they don't lose that much, which is not encouraging).
Finally, in the Graham sense - an investment is something that promises a return and safety of capital - shorting is not really an investment strategy on its own, since it does not provide safety of capital. Perhaps combined with another strategy it might be part of an overall investment. An investor, strictly defined, would not short as an activity in its own right.
posted by i_am_joe's_spleen at 3:30 PM on November 7, 2005
Are you a hedge fund? No? Then don't short stock.
Also, same applies for going long stock.
Actually, just buy index funds unless you make investing your full-time job and can spend thousands of dollars on resources such as equity research and a Bloomberg terminal.
posted by mullacc at 3:47 PM on November 7, 2005
Also, same applies for going long stock.
Actually, just buy index funds unless you make investing your full-time job and can spend thousands of dollars on resources such as equity research and a Bloomberg terminal.
posted by mullacc at 3:47 PM on November 7, 2005
Let me re-phrase that...
The reason the amateur investor should avoid shorting has nothing to do with the pitfalls of shorting. The reason to avoid it is the same as the reason an amateur should avoid making an individual stock picks: you're an amateur in a world dominated by professionals. Well-capitalized professionals. Well-informed professionals. The amount of "public" information that is really only available to rich professional investors makes me sick. The retail investor without a HUGE brokerage account is fresh meat.
You think you can pick out a failing company? Fucking Goldman Sachs and CSFB couldn't figure out that Refco was going to blow up and they had just done the IPO in August. Doing an IPO in the post-Spitzer, SOX world is liking having a full-cavity search. And believe me , Goldman Sachs would give their fees right back this instant to get their name off that IPO.
Things like Refco catch everyone off guard. But with thousands of hardcore pros investing billions of dollars on behalf of hedge funds - the amateur investor is fucked.
The only style of investing I can even fathom for the retail guy is to buy a few shares of a good company and hold it for 10+ years.
posted by mullacc at 4:03 PM on November 7, 2005
The reason the amateur investor should avoid shorting has nothing to do with the pitfalls of shorting. The reason to avoid it is the same as the reason an amateur should avoid making an individual stock picks: you're an amateur in a world dominated by professionals. Well-capitalized professionals. Well-informed professionals. The amount of "public" information that is really only available to rich professional investors makes me sick. The retail investor without a HUGE brokerage account is fresh meat.
You think you can pick out a failing company? Fucking Goldman Sachs and CSFB couldn't figure out that Refco was going to blow up and they had just done the IPO in August. Doing an IPO in the post-Spitzer, SOX world is liking having a full-cavity search. And believe me , Goldman Sachs would give their fees right back this instant to get their name off that IPO.
Things like Refco catch everyone off guard. But with thousands of hardcore pros investing billions of dollars on behalf of hedge funds - the amateur investor is fucked.
The only style of investing I can even fathom for the retail guy is to buy a few shares of a good company and hold it for 10+ years.
posted by mullacc at 4:03 PM on November 7, 2005
Seems to me that buying puts is not much more safe than selling short.
Well, duh. I think the payoff diagrams are part of high school textbooks nowadays. Nonetheless, an unleveraged investor who is long options will never be subject to a call, and he will always know his maximum loss.
Trading options is probably not such a good idea for someone who isn't comfortable with plain old stocks.
A child could understand put-call parity, which is all a vanilla options investor really needs to understand.
(Note that professionals on average underperform the index, even if they don't lose that much, which is not encouraging).
No. Professionals and amateurs can not both lag the market! They can only both lag the market net of fees.
Actually, just buy index funds unless you make investing your full-time job and can spend thousands of dollars on resources such as equity research and a Bloomberg terminal.
Do you claim that the low-P/E effect and small-firm effect have been arbitraged away? And unless you pick your index carefully, you'll probably be harmed by home bias.
The only style of investing I can even fathom for the retail guy is to buy a few shares of a good company and hold it for 10+ years.
Representativeness heuristic, defined. Tsk, tsk.
Here's a tip for you, wgp-- never take financial advice from AskMe.
posted by Kwantsar at 4:56 PM on November 7, 2005
Well, duh. I think the payoff diagrams are part of high school textbooks nowadays. Nonetheless, an unleveraged investor who is long options will never be subject to a call, and he will always know his maximum loss.
Trading options is probably not such a good idea for someone who isn't comfortable with plain old stocks.
A child could understand put-call parity, which is all a vanilla options investor really needs to understand.
(Note that professionals on average underperform the index, even if they don't lose that much, which is not encouraging).
No. Professionals and amateurs can not both lag the market! They can only both lag the market net of fees.
Actually, just buy index funds unless you make investing your full-time job and can spend thousands of dollars on resources such as equity research and a Bloomberg terminal.
Do you claim that the low-P/E effect and small-firm effect have been arbitraged away? And unless you pick your index carefully, you'll probably be harmed by home bias.
The only style of investing I can even fathom for the retail guy is to buy a few shares of a good company and hold it for 10+ years.
Representativeness heuristic, defined. Tsk, tsk.
Here's a tip for you, wgp-- never take financial advice from AskMe.
posted by Kwantsar at 4:56 PM on November 7, 2005
"A child could understand put-call parity, which is all a vanilla options investor really needs to understand."
Glad to hear it! I've been doing quite well with my options trading habit, and I don't think I've ever put the notion of put-call parity to any real practical use. I suppose everyone has their own style. Me, I prefer to know a thing or two about the underlying instrument before I start buying options on it.
never take financial advice from AskMe.
Maybe that's good advice. But no matter where you go for advice about the stock market, you will have no trouble finding someone else to tell you exactly the opposite.
posted by sfenders at 5:36 PM on November 7, 2005
Glad to hear it! I've been doing quite well with my options trading habit, and I don't think I've ever put the notion of put-call parity to any real practical use. I suppose everyone has their own style. Me, I prefer to know a thing or two about the underlying instrument before I start buying options on it.
never take financial advice from AskMe.
Maybe that's good advice. But no matter where you go for advice about the stock market, you will have no trouble finding someone else to tell you exactly the opposite.
posted by sfenders at 5:36 PM on November 7, 2005
Kwantsar: Do you have anything to say that would actually counter the claims I made? Or add at all to answer to the question? You're just nitpicking my general comments aimed at an audience whose knowledge of jargon/financial theories is unknown.
Do you claim that the low-P/E effect and small-firm effect have been arbitraged away? And unless you pick your index carefully, you'll probably be harmed by home bias.
No. I don't claim that either have been arbitraged away. I would claim that the average retail investor will have difficulty accurately calculating P/E ratios for a lot of firms. Because a) historical P/E ratios are less relevant than forward P/E ratios, which is what drives the market and it costs money to receive EPS estimates and b) companies trade on normalized P/E ratios which require various adjustments and add-backs to reported EPS. Most research analyst do this for clients (again, too expensive to get) or the hedge funds / institutional investors do it themselves (which requires financial/accounting knowledge and time). To take advantage of the low P/E-effect, a retail investor would have to invest a ton of time and/or money to get good data from which to make invest decisions. Even with good data, what is a low P/E? What is the benchmark to determine a low P/E? Those are answerable questions, but they require a good deal of time to work out.
And for the small-firm effect. Um, I guess I don't understand what you mean by that. Small firms tend to be riskier and grow faster - so, that's a risk/reward trade-off to be made as part of one's asset allocation decision. One would probably make that allocation by choosing a small cap index fund, not by picking any individual stock because it's "small."
Representativeness heuristic, defined. Tsk, tsk.
First of all - I said I could "fathom" it. I didn't say I endorsed it. I don't engage in it and I wouldn't recommend it to the average retail investor. Also, the pdf you link to doesn't really address what I'm talking about. That study referred to what financial analyst determine to be "good companies" and that they probably confuse a "good company" with a "good stock" - I would agree that the advice of these analysts should be viewed with skepticism. I didn't mean to imply that that is how one should make investment decisions - what I was really referring to was a deep-dive fundamental analysis of a company which leads to a stock purchase with an investment horizon of 10+ years. And that study only references one-year returns - totally irrelevant in my mind. And finally, here is part of the article's conclusion: "Thus, these empirical results suggest that the cognitive bias hypothesis can not be accepted in this study." Maybe I'm missing something - was there a reason you linked to that study besides showing off your ability to access academic research?
posted by mullacc at 5:41 PM on November 7, 2005
Do you claim that the low-P/E effect and small-firm effect have been arbitraged away? And unless you pick your index carefully, you'll probably be harmed by home bias.
No. I don't claim that either have been arbitraged away. I would claim that the average retail investor will have difficulty accurately calculating P/E ratios for a lot of firms. Because a) historical P/E ratios are less relevant than forward P/E ratios, which is what drives the market and it costs money to receive EPS estimates and b) companies trade on normalized P/E ratios which require various adjustments and add-backs to reported EPS. Most research analyst do this for clients (again, too expensive to get) or the hedge funds / institutional investors do it themselves (which requires financial/accounting knowledge and time). To take advantage of the low P/E-effect, a retail investor would have to invest a ton of time and/or money to get good data from which to make invest decisions. Even with good data, what is a low P/E? What is the benchmark to determine a low P/E? Those are answerable questions, but they require a good deal of time to work out.
And for the small-firm effect. Um, I guess I don't understand what you mean by that. Small firms tend to be riskier and grow faster - so, that's a risk/reward trade-off to be made as part of one's asset allocation decision. One would probably make that allocation by choosing a small cap index fund, not by picking any individual stock because it's "small."
Representativeness heuristic, defined. Tsk, tsk.
First of all - I said I could "fathom" it. I didn't say I endorsed it. I don't engage in it and I wouldn't recommend it to the average retail investor. Also, the pdf you link to doesn't really address what I'm talking about. That study referred to what financial analyst determine to be "good companies" and that they probably confuse a "good company" with a "good stock" - I would agree that the advice of these analysts should be viewed with skepticism. I didn't mean to imply that that is how one should make investment decisions - what I was really referring to was a deep-dive fundamental analysis of a company which leads to a stock purchase with an investment horizon of 10+ years. And that study only references one-year returns - totally irrelevant in my mind. And finally, here is part of the article's conclusion: "Thus, these empirical results suggest that the cognitive bias hypothesis can not be accepted in this study." Maybe I'm missing something - was there a reason you linked to that study besides showing off your ability to access academic research?
posted by mullacc at 5:41 PM on November 7, 2005
Here's a tip for you, wgp-- never take financial advice from AskMe.
Where should one take financial advice from?
posted by afroblanca at 6:14 PM on November 7, 2005
Where should one take financial advice from?
posted by afroblanca at 6:14 PM on November 7, 2005
mullacc - what you say makes good sense for investments made for 10 years and more. Shorter term, other factors that you haven't even mentioned become far more important to what the market does than say P/E. Emotion, momentum, rumour, suggestion, interpretation, promotion, etc. Some people do manage to consistently trade profitably on these things, despite occasionally being told it's impossible. I think the Internet has made it possible for small-time amateurs like me to have some chance of being successful at it.
Where should one take financial advice from?
Well, I like to keep track of all the advice, from all sides, and believe none of it.
posted by sfenders at 6:27 PM on November 7, 2005
Where should one take financial advice from?
Well, I like to keep track of all the advice, from all sides, and believe none of it.
posted by sfenders at 6:27 PM on November 7, 2005
I'm just wandering through, but I must say that as a geek, I really, really, really want a Bloomberg terminal now. Damn you... I can barely afford web on my cellphone, and now I want a $1200/mo subscription service.
posted by Netzapper at 6:52 PM on November 7, 2005
posted by Netzapper at 6:52 PM on November 7, 2005
sfenders: A good number of hedge funds have made their managers rich and delivered the magical 20% annual return to their LPs based on what you say. If you say you've been successful, I believe you. But my follow-up questions would be 1) for how many years? and 2) how much time do you invest in it?
My reasoning for question #1 is pretty basic - if you've been successful for only, say, 5 years in a row, you cannot rule out luck. Now, if you've strung together more than 5 years it begins to tell a more convincing story. The Buffets of the world have shown that investing based on intrinsic value has merit (with all the caveats about Buffet's strategy of buying whole companies and all), but I wonder if anyone has really established an unquestionable track record using your strategy? And the prop equity desk of Goldman Sachs doesn't count (they ain't amateurs).
And what I'm trying to get at with question #2: are you really an amateur? Do you have Level II NASDAQ access? If so, you're investing a lot more time and money than most retail investors.
I'm not trying to deny your success or anything. If it's working and you enjoy it - more power to you. The key will be when (and if) you start losing money do you question your tactics or do you question the whole strategy?
posted by mullacc at 7:09 PM on November 7, 2005
My reasoning for question #1 is pretty basic - if you've been successful for only, say, 5 years in a row, you cannot rule out luck. Now, if you've strung together more than 5 years it begins to tell a more convincing story. The Buffets of the world have shown that investing based on intrinsic value has merit (with all the caveats about Buffet's strategy of buying whole companies and all), but I wonder if anyone has really established an unquestionable track record using your strategy? And the prop equity desk of Goldman Sachs doesn't count (they ain't amateurs).
And what I'm trying to get at with question #2: are you really an amateur? Do you have Level II NASDAQ access? If so, you're investing a lot more time and money than most retail investors.
I'm not trying to deny your success or anything. If it's working and you enjoy it - more power to you. The key will be when (and if) you start losing money do you question your tactics or do you question the whole strategy?
posted by mullacc at 7:09 PM on November 7, 2005
True, I haven't been successful for nearly long enough to convince even myself that it's not just luck in my case. That will take many years. But I do know of a few people who have records that are much more convincing.
I didn't mean to imply anything substantial about my own strategy. I do take "value" into account where I can, along with macro trends and such. And yes, I'm spending way too much time on it and have much better tools than "most retail investors". Recently I've been taking quite a lot of risk, and I'm prepared for the eventuality that I might lose most or all of my money. I know exactly what would have to happen for that to occur, and it's far from impossible.
Anyway, yeah, the real professionals still have some advantages. But nothing like as much as they used to versus those who are willing to spend the immense amount of time and effort that it takes to learn to use all the available tools.
posted by sfenders at 8:04 PM on November 7, 2005
I didn't mean to imply anything substantial about my own strategy. I do take "value" into account where I can, along with macro trends and such. And yes, I'm spending way too much time on it and have much better tools than "most retail investors". Recently I've been taking quite a lot of risk, and I'm prepared for the eventuality that I might lose most or all of my money. I know exactly what would have to happen for that to occur, and it's far from impossible.
Anyway, yeah, the real professionals still have some advantages. But nothing like as much as they used to versus those who are willing to spend the immense amount of time and effort that it takes to learn to use all the available tools.
posted by sfenders at 8:04 PM on November 7, 2005
mullacc--First, I'm sorry for being a dick.
Now that that's out of the way:
1. "Buy a few shares of a good company" is a textbook behavioral finance mistake, and it pisses me right off to see someone give such advice in AskMe.
2. The small-firm effect is an anomaly precisely because MPT (and the CAPM) can not explain the outperformance of small fims.
3. You're out to lunch on the low P/E effect, as well. You don't need to do fancy adjustments, or take forward P/Es.
posted by Kwantsar at 9:32 PM on November 7, 2005
Now that that's out of the way:
1. "Buy a few shares of a good company" is a textbook behavioral finance mistake, and it pisses me right off to see someone give such advice in AskMe.
2. The small-firm effect is an anomaly precisely because MPT (and the CAPM) can not explain the outperformance of small fims.
3. You're out to lunch on the low P/E effect, as well. You don't need to do fancy adjustments, or take forward P/Es.
posted by Kwantsar at 9:32 PM on November 7, 2005
Kwantsar:
1. It pisses me off that you can't read my comments. I specifically said that I am not giving that advice. But if someone wanted to argue their stock picking strategy with me, I'd probably be more accepting of that strategy. And the strategy I'm referring to is exactly what the DrKW research piece (your "behavioral finance" link) describes.
2. So what does this mean? Does this somehow invalidate what I said about picking a small cap index fund? The link you provide makes a distinction between value stocks and small company stocks. I agree that CAPM can't explain the outperformance of value stocks - but I don't see why a CAPM adjusted for a small company premium and using an asset beta based on a set of comparable companies cannot explain the performance of small company stocks? That article points out the problems with volatility and value stocks, but doesn't say the same about small company stocks.
3. Good luck applying this. How would you invest using this knowledge? If you pick any individual stock, you most definitely will need to make adjustments and use forward P/E to find out if that company is indeed trading at a "low" P/E. If you can buy an index fund that removes the problem of picking out individual stocks, then fine, you're onto something.
posted by mullacc at 2:00 PM on November 8, 2005
1. It pisses me off that you can't read my comments. I specifically said that I am not giving that advice. But if someone wanted to argue their stock picking strategy with me, I'd probably be more accepting of that strategy. And the strategy I'm referring to is exactly what the DrKW research piece (your "behavioral finance" link) describes.
2. So what does this mean? Does this somehow invalidate what I said about picking a small cap index fund? The link you provide makes a distinction between value stocks and small company stocks. I agree that CAPM can't explain the outperformance of value stocks - but I don't see why a CAPM adjusted for a small company premium and using an asset beta based on a set of comparable companies cannot explain the performance of small company stocks? That article points out the problems with volatility and value stocks, but doesn't say the same about small company stocks.
3. Good luck applying this. How would you invest using this knowledge? If you pick any individual stock, you most definitely will need to make adjustments and use forward P/E to find out if that company is indeed trading at a "low" P/E. If you can buy an index fund that removes the problem of picking out individual stocks, then fine, you're onto something.
posted by mullacc at 2:00 PM on November 8, 2005
The Kirk Report had some things to say today on the subject of short-selling.
posted by sfenders at 3:50 PM on November 8, 2005
posted by sfenders at 3:50 PM on November 8, 2005
Response by poster: Thanks to all for the info and insight.
posted by weapons-grade pandemonium at 8:18 AM on November 9, 2005
posted by weapons-grade pandemonium at 8:18 AM on November 9, 2005
This thread is closed to new comments.
posted by electric_counterpoint at 11:45 AM on November 7, 2005