Confessions Of A Value Investor: A Few Lessons In Behavioral Finance

A must read presentation for the reflexive and reflective traders/investors in all of us. For the crux of the presentation please turn to slides 43-47 which provides a wonderful counterargument to why every time you hear some "expert" on CNBC say you should buy a stock because it is cheap, consider the following just as logical alternatives: 1) fraud, 2) value trap, and most relevantly for our current market situation 3) bubble market.At least $10 trillion in household wealth may have been saved if people followed these three simple observations at the peak of the last credit bubble in 2007. Of course, this time it is different.

h/t My Investing Notebook

Comments

[Chopshop]

from my favorite author (not named Marla Singer), Jonah Lehrer:

Randomness and God

The world is a confusing place. Correlation looks like causation; the signal sounds like the noise; randomness is everywhere. This raises the obvious question: How does the human brain cope with such an epistemic mess? How do we deal with the helter-skelter of reality? One approach would be to ground all of our beliefs in modesty and uncertainty, to recognize that we know so little and understand even less.

Needless to say, that's not what we do. Instead of grappling with the problem of induction, we believe in God. Instead of applying Bayesian logic, we slip into rigid ideologies, which lead us to neglect all sorts of salient facts ....

.... On the one hand, it's a mostly accepted fact that the stock market is a random walk. (Some smart behavioral economists disagree.) Nevertheless, it's pretty clear that, for the vast majority of investors, it's safe to assume that the market is so efficient that it's effectively random. So how do we react to this information? Do we stop trying to outsmart the S&P 500 and instead sink our savings into a low cost index fund? Do we seek the safety of bonds? Not at all. Instead, we become day traders.

This all reminds me of one of my favorite Bob Dylan quotes: "I accept the chaos. I hope it accepts me."

left / right brain ~ The Master and his Emissary

[Blindweb]

Interesting.  I may check it out.

Spinning dancer right/left brain test:

http://www.youtube.com/watch?v=9CEr2GfGilw

See if you can get it to switch directions at will...If not check out Lao Tzu

[anony]

HE obviously has never met Mr. Frontrunning and Mr. High F. Trading.

It ain't random, noissome, chaotic, confusing,  when you create the market.

Lord Blankfiend has overcome all of these as have madoff, geithner, orszag, bernanke,  summers, paulson, greenspan, rubin, friedman, fuld, cassano, frank, thain, dodd, mozillo, o'neal, prince,sanderson, gensler, shapiro,yellin and others.

In fact, it's downright serene, edenic, and very very profitable.

[Rainman]

Thanks, TD. A nice primer on why we are all crazy and obsessive, only in different ways.

[BennyBoy]

But I thought the Wisdom of Crowds was "IN"!

[Missing_Link]

Some great points in here, but the author fundamentally rejects the possibility that purely technical trading systems can work at all.

The spreadsheet showing an example of buy-and-hold returns vs. active trading is particularly heinous: buy-and-hold beats active trading?  Really?

Always and everywhere?

It sort of depends on what kind of active trading system you're using and how good it is, right?

In order for someone to prove that active trading systems can't work, they have to disprove all of them, don't they?  And they can't, because most of them are proprietary and unknown.

He also assumes that mathematically based trading systems are based on the statistics you learn in college.  That's not necessarily the case; there are plenty of algorithmic trading systems that don't rely on statistics at all.

[dis-stressed]

Teriffic presentation. Well worth a look.

[tenaciousj]

i think i officially hate scribd now...

[Convection Fry List]

Reminds me of the parade of clowns on CNBS predicting this past Friday a huge market sell-off if the health care bill passed...

And whatever happened to the "if the dollar breaks 76" the stock market will see armageddon again crowd?

[Lux Fiat]

Is there a link to a non-scribd version of this file that has links to the once-embedded video clips?  The investing notebook site one is also sans clips links.  A well-done compilation of some of the better points in investing advice.

[Pat Shuff]

  I plead guilty on all 327 counts. Displaying profound recidivism,

  life,  no hope of parole. If you're happy and you know it clank your chains.

[Blindweb]

The Frequency Magnitude part reminds me of a couple things:

-The most dangerous activities for most Americans are ingesting foods and liquids, and driving; yet they put little resources into these areas.

-Assuming polygraphs aren't complete b.s. and their success rate is somewhere between 80-90%, those are pretty bad odds for possibly completely destroying someone's life.

On the other hand their are times when it pays to gamble.  When you're backed into a corner  If I believe my area is going to be nuked next week but I don't have the resources to escape it would make sense to go to a casino and gamble at below 50% odds.

Also I'm always very reluctant to buck evolutionary trends.  Millions and billions of years of fine tuning is hard to go against.  You better make sure you aren't missing an overarching variable.  I like that the author makes observations with out making value judgements.  It may be in a person's best interest to like music others like.  Music has no objective value.  As the Buddha said, "Everything is transient."

The idea that you can apply the result from the multiple music selection "universes" to reality is ridiculous.  Reality only happens once.  Once you introduce the concept of a do-over you've introduced a variable contrary to reality.  That's the major flaw of most economists.  They think laboratory and mathematical results can be applied to reality directly...which leads to the next idea... 

I like that pissing on fences quote.  You always have to interpret.  If you know anything about how the world works you should know that solar panels and other green technologies are going to be a giant failure.  In the long run do you really think you're going to beat the efficiency of plants and animals with your plastic and metal toys.

And what's the Mark Twain quote...something like...There's lot's of smart people out there but most can't keep their shit together.  A.C. "doubt is a good servant but a bad master".  "Consciousness is a symptom of dis-ease"  You need a high amount of routine.  Otherwise you're just throwing the puzzle pieces down hoping they got together.  Concentrate too much on black swans and you'll be ground down slowly spreading your resources thin.

[jdrose1985]

Pretty interesting observations.

A recovered heroin and cocaine addict, I can vouch for the validity of the role dopamines play in investing (focusing on short term gains leads to long term ruin). It was a very interesting chapter. The odds of a daytrader "retiring" reminds me of the "live by the sword, die by the sword" idea. Past performance is not indicative of future returns blah blah blah.

Entrepreneurial gains are definitely the way to go, methinks. Giving portions to seven, or even eight, for we never know which disasters may fall upon the land (solomon) is logical leads me to believe the whole black swan event concept precedes our time.

Is there a special trait which makes mr gross the "bond king"? nope

[mark456]

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