Wednesday, May 18, 2005
The Movement of Price
If you haven't caught on yet, I don't believe in "investment" when it comes to equities. Although my experience is limited, I will eventually touch on how I would approach investing for retirement and the future - mostly focusing on municipal/corporate bonds as well as an overview of other similarly useful assets.
However, before I enter into an examination of why so many fail at both investing and trading, I feel a quick and dirty overview of asset pricing is due. The simple fact is that in all open markets, the forces of supply and demand, working unbridledly, will find the price equally beneficial to both buyers and sellers. And, even though it is perhaps possible (although unpractical) to gauge the entire supply and demand of a good at various prices, it is impossible to accurately and consistently predict the supply and demand of a good at various prices into the future. What may influence millions (or even a handful, the number really doesn't matter) of market participants at one point, may be moot at another. The fact is, with practically an infinite number of changing conditions, needs and sentiments, one can not reliably forecast much of anything.
The stern believers of market forecasting rely on the theory that market behavior exhibits [no matter how slight] a dependency on the past - i.e. the past affects the future. Forecasters use this idea in an attempt to divulge future market paths from past behavior. This is the reasoning applied to the idea of the existance of "trends", which I definately do believe in. A trend can be depicted by a time period in which increases of an asset price cause market participants to be more likely to purchase said asset, or vice versa. Just like in price, however, some market participants claim to see trends in numerous other factors and measures of market activity such as volatility, NYSE sentiment indicators, etc. What I do not believe in is the ability to forecast the beginnings and endings of these trends due to the fact that what appears as a "trend" to humans is simply a perfectly normal statistical artifact. As an example, while many would consider the movement below an "up-trend", it is simply a random walk - at any given point the probability of an increase or decrease is equal, 50% each.
As a comparison, see the behavior of practically any stock during a bull market, below is Texas Instruments leading up to the dot-com crash:
Now, it is important to understand that even though it is quite possible that market movements follow a random walk, ipso facto making them as impossible to forecast as the flip of a coin, there are definite and specific money-making opportunities available to the keen market participant - more later, as you might imagine. For a good look into the dynamics of price movement, random walk, EMH (efficient-market hypothesis), as well as a good introduction into the possibilities behind market inefficiences and Mandelbrot's own view of things, I suggest The (Mis)Behavior of Markets. For a more focused look into the random-ness of markets, as well as a similar approach as Mandelbrot to popular models of risk, Taleb's Fooled By Randomness is a strong read.
However, before I enter into an examination of why so many fail at both investing and trading, I feel a quick and dirty overview of asset pricing is due. The simple fact is that in all open markets, the forces of supply and demand, working unbridledly, will find the price equally beneficial to both buyers and sellers. And, even though it is perhaps possible (although unpractical) to gauge the entire supply and demand of a good at various prices, it is impossible to accurately and consistently predict the supply and demand of a good at various prices into the future. What may influence millions (or even a handful, the number really doesn't matter) of market participants at one point, may be moot at another. The fact is, with practically an infinite number of changing conditions, needs and sentiments, one can not reliably forecast much of anything.
The stern believers of market forecasting rely on the theory that market behavior exhibits [no matter how slight] a dependency on the past - i.e. the past affects the future. Forecasters use this idea in an attempt to divulge future market paths from past behavior. This is the reasoning applied to the idea of the existance of "trends", which I definately do believe in. A trend can be depicted by a time period in which increases of an asset price cause market participants to be more likely to purchase said asset, or vice versa. Just like in price, however, some market participants claim to see trends in numerous other factors and measures of market activity such as volatility, NYSE sentiment indicators, etc. What I do not believe in is the ability to forecast the beginnings and endings of these trends due to the fact that what appears as a "trend" to humans is simply a perfectly normal statistical artifact. As an example, while many would consider the movement below an "up-trend", it is simply a random walk - at any given point the probability of an increase or decrease is equal, 50% each.
Now, it is important to understand that even though it is quite possible that market movements follow a random walk, ipso facto making them as impossible to forecast as the flip of a coin, there are definite and specific money-making opportunities available to the keen market participant - more later, as you might imagine. For a good look into the dynamics of price movement, random walk, EMH (efficient-market hypothesis), as well as a good introduction into the possibilities behind market inefficiences and Mandelbrot's own view of things, I suggest The (Mis)Behavior of Markets. For a more focused look into the random-ness of markets, as well as a similar approach as Mandelbrot to popular models of risk, Taleb's Fooled By Randomness is a strong read.
