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1 Speculator or Investor

The Model

When trying to represent a financial system there are three ways I can think of;
  • Narrative - The most common and most popular i.e. "But the flood of new Chinese silver investors isn’t the only factor driving up silver prices. The increased use of silver in everything from solar cell technology to medicine is pushing up prices as well."
  • Mathematics - Where equations try to predict possible future scenarios.
  • Computer Modelling - Where computer programs use current data as a means of trying to predict possible future scenarios.
My instinct is that all have a role to play but that in the financial world narrative tends to be supplied unsubstantiated by any reliably sourced numbers. i.e. statements tend to be of the form "more of this means less of that" even when there are many other factors not considered.

Mathematics is diligently done, rather as if macro-economics could be predicted statistically as the result of the sum of independent random bodies, like in a well behaved gas. Notably even in physics, where there is energy input and other factors, the behaviour of large systems like the weather still defy simple models. Our atmosphere just does not become a nice even uniform soup.

Computer Modelling, I yet have to see a decent or indecent computer model of economics that doesn't just do the mathematics, i.e. its really a mathematical model.

I think to model markets you must represent individual bids and offers but even a good model probably won't do as well as our weather prediction computers do.

Lucas (1976) is an interesting paper on the deficiencies of macroeconomic models based on aggregates. Kydland and Prescott (1977) is also of interest.

Speculation

It is true that many markets might reach a nice balance of supply and demand if they were ever allowed to, but the crowds of speculators, who for lack of an effective model must remain reasonably ignorant of the future, drive the markets up and down based on opinion. (See Price with Time)

The truth or completeness of the opinion does not matter, what matters is the behaviour it invokes and the extent to which it propagates. Most importantly it must cause the phenomenon it claims to predict, i.e. the statement "Share prices will drop because of - anything plausible" causes share selling that causes prices to drop.

Nassim Nicholas Taleb defines a "Black Swan Event" [Wikipedia - Black Swan Theory] as one with the following three attributes.
  • First, it is an outlier, as it lies outside the realm of regular expectations, because nothing in the past can convincingly point to its possibility.
  • Second, it carries an extreme impact.
  • Third, in spite of its outlier status, human nature makes us concoct explanations for its occurrence after the fact, making it explainable and predictable.
Anyone who has speculated and watched a price chart rise and fall or any gambler, should know the psychology.
  • First they see a pattern and obtain some plausible justification for that pattern continuing.
  • Second when it doesn't it has an extreme impact.
  • Third they concoct explanations for its occurrence after the fact, making it explainable and predictable.
And so they repeat the cycle believing they have the correct model now.

So where what we believe is untrue or incomplete then we may well expect to see some black swan events. Not predicted because the theory of how things markets behave is sloppy and explained after the fact because its always easy to concoct a poor explanation of anything.

When reading the financial news you can clearly differentiate articles that of after the fact "The Nvidia share price dropped to day because Apple will not be using the Nvidia chipset in their latest tablet", and articles that predict the future "This might be a good time to sell your Nvidia shares because Apple will not be using the Nvidia chipset in their latest tablet". My experience is that the future predictors are rarely correct as they fail to see the wider picture, but sometimes they manage to knock over the first domino in a chain. If a big investor decides to move this is more likely to change things but at the very end of the day fundamentals will usually prevail. i.e. p/e ratios, dividends etc, but before the end of the day which could be decades the choppy waves can make and break.  

The News Chain

The search for the complete truth has to be the biggest mission, it turns the speculator into the investor, but can it ever be found? And even if it was can the force of the complete truth ever equal that of opinion.

http://solari.com for real financial advice.

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Financial opinion propagates based on plausibility to its audience, simplicity and of course a degree of sensationalism. Financial complete truth, or as complete as it is likely to be, rests in tables of statistics that most of the speculators don't give a damn about. Which would you prefer for dinner?

Since outcomes may be driven by opinion more than complete truth, it may be the case that the investor will do better to understand the opinions and mechanisms of opinion, before understanding the complete truth.So being close to the source of the opinion may be more important than being close to the source of the complete truth.

I am not saying that opinion may not be true, but it is usually incomplete. On a given matter opinions of varying degrees of completeness will independently spread. To read more see opinion.

Opinion spreads as news and how far up or down the news chain you are will determine how quickly you can buy or sell on the good or the bad news.

To do well you may need to live on the news not the complete truth.

Most of the information on which we act flows down to us through the news chain.

Understanding the relationship between the news and the truth is vital. An important question is will the truth stand up to the news or will it collapse under the pressure. Obviously investment decisions must be made with regard to this important consideration.

Investopedia - Trading On News Releases

"Occasionally reality cuts in and whacks us because belief doesn't drive everything."

Comedy of Errors

Today let me introduce you to two friends, Erroneous Principles and Erroneous Regrets.

Erroneous Principles

When the price drops;
  1. it is the start of a trend so sell,
  2. it is low so buy.
When the price rises;
  1. it is the start of a trend so buy,
  2. it is high so sell.
Buy it when its cheap, and sell it when its expensive, but when is it cheap and when is it expensive and why?

Expensive is NOT necessarily when it costs more than it ever has done.

Cheap is NOT necessarily when it costs less than it ever has done.

A down trend has a probability of turning and wiping you out.

Its a high on a down trend! Technical analysis my foot.

Erroneous Regrets

  1. I should have held my position longer.
  2. I should have pulled out sooner.

It is a classic mistake to regard a calculated decision not to participate in taking a gamble, as a mistake if the gamble would have paid off.

A decision must be the best it can be with the information available.

Articles

Interactive Brokers' Peterffy Lashes Out Against The Broken Market, As Nanex Conclusively Proves HFT's Were Cause For Flash Crash | ZeroHedge

Flash Trading

Interview and discussion with Joseph Saluzi of Themis Trading. He shares his thoughts regarding the flash trading occurring in the market. (Bloomberg News)

YouTube Video




Interview and discussion with David Rowelli of the Canaccord Adams. He gives his opinion about the potential clampdown in the market. (Bloomberg News)
BATS
AJAX?
NASDAQ


YouTube Video



The Day Trader

Peter Millman discusses his addiction to the stock market. Video by Vincent Laforet.

YouTube Video


The Rogue Trader

What makes a rogue trader? - FT.com

(C)2010 Tom de Havas. The information under this section is my own work it may be reproduced without modification but must include this notice.





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