William Gamble
Busting some investor myths

You can be successful making money by trading against people who do not understand that the past is simply a rough guide to coming events

Historians would be very familiar with one of the greatest investor myths. Any historian knows that history is just a rough guide to the future and that it does not repeat itself. Yet investors all over the world are desperately dredging up numbers from as long as 80 years ago in an effort to predict the future of markets. It doesn't work.
Let us start with the reason for this process. Despite the hype, all economists, investments advisors, financial analysts, investment bankers and pundits cannot do the one thing that they are promising to do. They cannot predict the future. No algorithm, no economic equation, no political analysis can do this. Yet they continue. The financial business is a lot like Hollywood. They are selling dreams.
Yet dreams must be based on something, in this case history. Take the famous Morningstar ratings. If you buy a five-star rated fund you are safe right? Millions of investors think so. During the carnage of 2008, investors in droves fled to the perceived safety of better-rated funds. Three-star funds lost $111 billion, four-star funds lost $14 billion, but five-star funds enjoyed $67.5 billion of net inflows.
Still it is important to read the fine print. All investment advertisements in the US contain the warning: "Past performance is no guide to future performance". The warning is there for a reason. Morningstar ratings are backward-looking, based on a fund's past performance. A recent study over the past ten years looked at the performance of 248 equity funds with five-star ratings at the start of the period. At the end of the period just four still kept that rank. Worse, almost 90% of the US equity funds with the rating lagged their category averages both for other mutual funds and for their benchmarks. Yet millions of investors - to say nothing of investment professionals from hedge fund managers to pension fund trustees religiously review past performance and project it into the future.
The great economist and Nobel Laureate, Paul Samuelson, noted: "There is some evidence that last year's winners tend to repeat next year. But it is very slight. Mostly the effect comes from the fact that really bad funds stay bad. Their expenses are high, and their choices stay haphazard." So perhaps the stars are elusive, the real donkeys are not.
Another favourite of financial historians is the venerable Dow Theory. This theory which involves analysis of empirical data, namely the price history of markets and securities, was created by Charles Dow, the founder of Dow Jones, the publisher and news agency. The Dow Theory's shining moment came in 1929, when it encouraged investors to sell. For its followers it has all the hallmarks of a true religion including magic and mysterious phrases like 200 day moving averages, head and shoulders and even the terrible 'death cross'. Frightening!
Dow Theory or technical analysis is supposed to help investors time their trades. For example, there have been 43 'sell' signals since 1920, but only 17 have been correct, an average of only 40%, slightly better than chance. But of course, a sell signal only comes after big declines in the averages, which is hardly helpful. Or take the death cross. This occurs when the market's 50-day moving average drops below its 200-day moving average. A death cross is supposed to envision below-average performances and has been very effective until 1990, when its predictive value dropped to statistical insignificance.
The difference in the effectiveness of the death cross does tell you about one of the limits of using historical data to predict the future. According to a professor of finance, one reason the significance of such events like the death cross have lost their value is that too many investors are trying to follow them. The use of personal computers and online databases has allowed millions of investors access to information and strategies that were once available to only a few. This creates its own paradox. The reason why Dow Theory is important is not because it has any value in predicting trends, but that investors believe that it has value.
The idea that historical analysis has value could lead to perhaps a really useful tool for investors. The 'Lex' column in the Financial Times ran a satirical piece about the success of a mythical money manager called Contrarian Partners. The strategy of Contrarian Partners is "to mine the research produced by investment banks every six months to establish consensus trading strategies. Then trade against them." The strategy was remarkably effective. The adage that history never repeats itself then has special meaning because you can be successful making money by trading against people who do not understand that the past is simply a rough guide to coming events. A mere proxy for the possible, not a data point for the inevitable.

(The writer is president of Emerging Market Strategies and can be contacted at [email protected] or [email protected]).



Sunil Date

7 years ago

One cannot predict the future and cannot rely on the past. Then what is the authors suggestion ? The article is not complete.
Fundamental analysis ? But that too looks at the past and predicts the future.
Forget investing in stocks ? Cannot be a solution.

Deepak K Rao

7 years ago

Thanks for such a interesting article. In fact, its very true too.
There is nothing new in the stock market, since history always repeats. If you do not read and understand what happened in the stock market in the past, then you condemned to live in the past. But be cautious since it need not happen in the same way how it had happened in the past.
Let us look at the opinion of some of the world's greatest investment writers and thinkers;
'History never repeats itself exactly, but you owe it to yourself to be acquainted with the bear markets of yesteryear. At least if history does then repeat itself you can’t say that you weren’t warned'.
"Edmond Warner"
The stock market will continue to be essentially what it always was in the past – a place where a big bull market is inevitably followed by a big bear market.
In other words, a place where today’s free lunches are paid for, doubly tomorrow.
"Benjamin Graham"
Wall Street never changes. The pockets change, the suckers change, the stocks change, but Wall Street never changes because human nature never changes.
"Jesse Livermore"
When a person with experience meets the person with money, the person with experience gets the money. And the person with money gets the experience! Moral: In the stock market always learn by others experience and never ever try to learn by your own experience. If you try to learn by your own experience, then lose your money first and get experience!

Edelweiss: Can you? Umm… maybe!

The commercial is artfully executed, but the ‘can do’ idea has been done to death

The 'can' word may or may not have been inspirational for the Americans, but Shri Obama's message seems to have inspired Edelweiss, an investment banking, brokerage services, asset management and financing company.
Edelweiss's new corporate campaign tries to tap into the aspirations of the young, new, restless India… one that is too impatient to wait for its turn in the land of riches. The commercials feature a collage of very impatient folks, each waiting for something to happen fast, clearly because no one wants to fund their dreams. A lady exec is seen blowing bubble gum from behind a laptop, another exec has crashed out in his cubicle, another one's business plans go down the paper shredder. Along the way we see more shots… couples planning a second home, someone wanting to launch a satellite, another one wants to power cities and so on and so forth. Finally, the predictable happens. An air-walking suit changes 'CAN'T' into 'CAN'. Yes, Obama would be mighty pleased, he can even demand a royalty… yes, he can!   
Okay, first the good thing about the commercials: The various shots are tastefully, artfully executed, and therefore quite pleasing on the eye. These ads are an art director's dream come true. So that's great. And sadly, that's where all the good work ends.
The 'CAN DO' idea is pretty trite to say the least, and fails to engage with the viewer, leave alone inspire action. We have seen enough of this 'can do' drivel before. The idea just doesn't have the legs to stand on. Result: Yet another pretty set of commercials with little meat to support them. Eminently forgettable and dumped from the mind, exactly as a paper-shredding job. Might as well visit an art gallery. The other bigger problem is while I can imagine, having watched the commercials, that Edelweiss is the go-to joint for bringing my mad ideas to life, we are never told how exactly they can help us achieve this. Sure, they can't put out their standard operating charts in a TVC, but some amount of basic info would have been more useful than just shots of frustrated executives. These commercials are like a vague window-dressing exercise for a mysterious boutique. Could work for a couture brand, but not for an investment company, where my future is on the line. Where my dreams could so easily get, er, canned!  


Fuelled Rally

Cairn India shot up 7% after raising its  estimate of oil reserves at its Rajasthan field...

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