Efficient Markets, RIP

[smedleyb]

This has been a great thread that was triggered by the discussions in another thread that got of topic somewhat and there too people made their opinions and had drawn a line in the sand. https://forum.mrmoneymustache.com/investor-alley/telefonica-good-to-go-or-stay-away/msg15752/#msg15752

It has been hard to keep up with the speed of responses.

John - your summary is fairly accurate about their agreements and disagreements.

I am sure I can quote a bunch of posters above but the short story is that I do think that individuals can beat the market over time but only if they are educated, informed and willing to take on more risk.  While information is public there is still plenty of information that is not read or interpreted in different ways. Also keep in mind that professional managers have difficulty beating the market simply because their assets under management become way to big and their analysis starts being passed to recent grads or whatever (Buffett is struggling with this issue, I am sure he could still find a $50MM company that would produce outsized returns but the fact is that it wouldn't even move the dial a fraction so he can't focus on those types of deals)

If you want to invest in individual stocks you need to have a solid understanding of financial and trend analysis, as well as willingness to understand sectors and industry drivers/trends. You also need to have the rright emotional demeanor and risk tolerance. I tend to believe that the majortity of people don't have the these abilities, and then those that do don't have the willingness to do the work involved.  Bottom line then almost everyone should go the index route.

Yes, it has been fun!

I think a huge point of disagreement between myself and the proponents of EMH is the use of technical or trend analysis in formulating an investment thesis.  The fact is charts are public, available for everyone to see, and provide clues as to the future behavior of stocks.  It's an inductive practice, mixed with a bit of artistic interpretation, but I'm blow away by how reliable it is.  Of course misreadings of charts, levels, and moving averages is common -- it's hardly deductive science.  But it's way more accurate than not, and has been a cornerstone of my investment process. 

Another point of disagreement between myself and some posters is the idea that selling assets to raise cash is somehow anathema to the mustachian goal of FI.  I realize MMM keeps very little cash on hand and plows everything back into stocks, rentals, etc; but my mode of though encourages high levels of cash (at least 50% in long term accounts) in order to (a) buffer ones portfolio against the volatility of the past decade, and (b) reserve some artillery for when the current cyclical bull runs its course and the market sells off again -- which I strongly believe it will since last time I checked you don't remedy a debt problem by issuing trillions more in debt, which is our brilliant leaders' response to the financial panic. 

When you have as much as I do in life -- and I put the monetary things at the bottom of the list -- it's impossible to not be optimistic about the future.  In fact, ,my children inspire me everyday to do better, be better, and share as much as possible with those around me. 

James, I'm not trying to convince anybody of anything.  I've been battling Arebelspy (look dude, I spelled it right!) and Grant since forever regarding my position on the stock market.  That will never change.  Yet I see the market as fraught with risk, corruption (flash crash, anybody?) and outright manipulation (the President's Plunge Protection Team, half myth, half real).  Individual investors need to protect themselves through education.  I honestly think this is a place where we can exchange ideas about the risks (and the rewards) inherent in the market.  I don't think Vanguard, Fidelity, or Schwab really give a fuck about the majority of us, what, with our little portfolios and our big dreams. 

But around here, people do give a fuck.  I give a fuck.

John Galt, nice synopsis and thanks for the breakdown (even if I think it needs a little tweaking, as I think there's more disagreement than meets the eye).

Mechanic baird, I know you think you're funny, but seriously, bring something worthy to the table, or just back off.  I'm capable of slinging insults too, but in the spirit of reconciliation, dialogue, and understanding, I'm willing to look the other way.  As far as a trading journal goes, it's not a bad idea and similar to what Arebelspy suggested to me.

Grant, I apologize for attacking your lack of investment experience or your current portfolio status.  That's irrelevant to the topic at hand.  If you wish to gain some insight into the ways in which EMH breaks down under scrutiny, read Soros' "Alchemy of Finance."  I don't expect you to back down at all -- it's what I like about you, really.  You're a smart fucking thinker with great arguments and a keen mind.  That's not empty praise, but a sincere observation.  Debating you can only sharpen my own understanding of my own investment process. 

Finally, Arebelspy, sorry putting you in the position of having to shut down 3 threads simultaneously.  I'll be on my best behavior going forward but I refuse to back down from my convictions about investing.  I'm passionate about warning people of the major structural imbalances still facing our economy, Europe's economy, the growing isolationism and nationalism pervading the globe, social unrest, the surge in structural unemployment in this country, the huge divide between the have's and have nots, etc.  Yet for every dollar I've made shorting markets, I've made 100 going long.  I too desire to see a future in which we all prosper and reach our financial goals, for us and our children.

(ps: Grant, I'd love to debate those salient points you laid out above;  and I promise I will very soon).

peace.

[arebelspy]

Thanks smedley. 

That post gained you a lot of respect in my mind.  I still don't agree with you on a lot of stuff, but I like your passion.

I know it'll get heated at times (myself included). Long as we try to keep the personal insults down, from both sides, and not bleed into other threads, it's all good.

We're all Mustachian. We're all human. We certainly have more in common than different. We're just passionate about our differences. ;)

[JohnGalt]

I think a huge point of disagreement between myself and the proponents of EMH is the use of technical or trend analysis in formulating an investment thesis.  The fact is charts are public, available for everyone to see, and provide clues as to the future behavior of stocks.  It's an inductive practice, mixed with a bit of artistic interpretation, but I'm blow away by how reliable it is.  Of course misreadings of charts, levels, and moving averages is common -- it's hardly deductive science.  But it's way more accurate than not, and has been a cornerstone of my investment process. 

Another point of disagreement between myself and some posters is the idea that selling assets to raise cash is somehow anathema to the mustachian goal of FI.  I realize MMM keeps very little cash on hand and plows everything back into stocks, rentals, etc; but my mode of though encourages high levels of cash (at least 50% in long term accounts) in order to (a) buffer ones portfolio against the volatility of the past decade, and (b) reserve some artillery for when the current cyclical bull runs its course and the market sells off again -- which I strongly believe it will since last time I checked you don't remedy a debt problem by issuing trillions more in debt, which is our brilliant leaders' response to the financial panic. 

I'm not sure if you meant this post to be the place for this - but I think what could really benefit the community much more than the philosophical debate between whether or not the typical person should attempt to trade individual stocks and/or attempt market timing (interesting though I find it) would be to explain and discuss the various methods and their pros/cons of stock valuation and predicting market trends.

I think it was already mentioned earlier, but an investments trade log to show how those same methods turn into actual trades would really go great either as part of the same thread or on it's own. 

[James]

I think a huge point of disagreement between myself and the proponents of EMH is the use of technical or trend analysis in formulating an investment thesis.  The fact is charts are public, available for everyone to see, and provide clues as to the future behavior of stocks.  It's an inductive practice, mixed with a bit of artistic interpretation, but I'm blow away by how reliable it is.  Of course misreadings of charts, levels, and moving averages is common -- it's hardly deductive science.  But it's way more accurate than not, and has been a cornerstone of my investment process. 

Another point of disagreement between myself and some posters is the idea that selling assets to raise cash is somehow anathema to the mustachian goal of FI.  I realize MMM keeps very little cash on hand and plows everything back into stocks, rentals, etc; but my mode of though encourages high levels of cash (at least 50% in long term accounts) in order to (a) buffer ones portfolio against the volatility of the past decade, and (b) reserve some artillery for when the current cyclical bull runs its course and the market sells off again -- which I strongly believe it will since last time I checked you don't remedy a debt problem by issuing trillions more in debt, which is our brilliant leaders' response to the financial panic. 

I'm not sure if you meant this post to be the place for this - but I think what could really benefit the community much more than the philosophical debate between whether or not the typical person should attempt to trade individual stocks and/or attempt market timing (interesting though I find it) would be to explain and discuss the various methods and their pros/cons of stock valuation and predicting market trends.

I think it was already mentioned earlier, but an investments trade log to show how those same methods turn into actual trades would really go great either as part of the same thread or on it's own.

I agree.  I think delving deeper into your methods, rational, and history would provide better framework for the discussion.  I feel our arguments and theories are well known and well documented, but yours are less well known and less well documented.  in short, instead of saying we or others are wrong, simply show and discuss what you actually do.  If you really want to convince me then let what you do stand on it's own logic and theory and start talking details and results.

[smedleyb]

I'm not sure if you meant this post to be the place for this - but I think what could really benefit the community much more than the philosophical debate between whether or not the typical person should attempt to trade individual stocks and/or attempt market timing (interesting though I find it) would be to explain and discuss the various methods and their pros/cons of stock valuation and predicting market trends.

I think it was already mentioned earlier, but an investments trade log to show how those same methods turn into actual trades would really go great either as part of the same thread or on it's own.

Hey man, it's as good a place as any. :)

I detected a reverse head and shoulders bottom in the SPX in early June which coincided with a wave of pessimism regarding Europe's future on the eve of the Greek elections.   The head was formed June 4 with the SPX touching 1267, and the neckline sat at roughly 1330.  A measured move works to 1390.

The positive outcome in Greece was anticipated on the Friday before and they closed the SPX above the 1330 neckline.  It seemed like smooth sailing  to 1390 until...

On Tuesday June 19th the SPX topped out at 1365 and immediately crashed back through the 1330 neckline (which should have been support) touching 1310 last week.  The rally on Wednesday caused the SPX to flirt with 1330 again, but it backed off this morning (after JPM announced some big trading losses), but jumped late in the day to flirt with that 1330 level again closing just a tad under at 1329.04. (1330 has now become resistance -- broken support becomes resistance; and conversely, broken resistance becomes support -- and  both support and resistance levels get weaker with each test),

Interestingly, the charts now show a head and shoulders top, with the head at 1365 and the neckline at 1306-1310, which projects -- if the neckline (1310) is broken, to a measured move to 1250.

In short, any movement between 1310-1330 in the SPX is just noise(with a bearish bias); a convincing move above 1330 (say, to 1340) negates the H&S top and the bulls are back in control with 1390 in their sights.  A break below 1310 (say, anything under 1300) means the H&S top is confirmed, unleashing the bears who will be gunning for 1250 in an effort to erase the SPX gains for the year.

The above represents the technical framework within which I'll attempt to understand the movement of the market over the next several weeks.  But his is just one piece of the puzzle.  Furthermore, groundbreaking news -- a war, a natural disaster, a huge earnings warning by a solid company -- can render these technical levels void in a flash.  Technicals are just one force moving stocks.

Again, this is an experiment to share a vernacular that is foreign to most.  But remember: there are so many technical based traders and trading programs that these chart formations, supports, and resistances, etc, become almost self-fulfilling prophesies.  They are actionable levels because so many people are acting on them.

[gently cowering behind desk in anticipation of verbal onslaught]

[Jamesqf]

I detected a reverse head and shoulders bottom in the SPX in early June...

Not, I hope, a verbal onslaught, but honest curiousity: how much time did you spend doing research, looking at charts, and so on in order to detect this?

It'd also be interesting to know how much time you spend on this on an ongoing basis, say hours per week, and what your return is, both as hourly wage and as ROI.

[smedleyb]

I detected a reverse head and shoulders bottom in the SPX in early June...

Not, I hope, a verbal onslaught, but honest curiousity: how much time did you spend doing research, looking at charts, and so on in order to detect this?

It'd also be interesting to know how much time you spend on this on an ongoing basis, say hours per week, and what your return is, both as hourly wage and as ROI.

Jamesqf, the patterns become apparent almost immediately.  And I don't spend much time, a few hours a week analyzing charts, reading news, etc. since I'm hardly what you would call an active day trader.  I wait for solid risk/reward swing trades (which take 2-14 days to unfold) before committing capital (in my trading account, where I've been trying to consistently churn out small gains rather than swing for the home runs).

And just like that, Europe eases conditions for repayment by Spanish banks and their averages are exploding higher this morning; US futures point to a 20 point pop in the SPX at the open, which immediately negates the bearish H&S top as the SPX looks to open nicely above 1340.  The positive news from Europe coupled with a bullish confirmation of the H&S bottom puts the bulls solidly in control.  Unless they relentlessly pound the market at the open (sell the news), which I doubt they will, there is strong conviction on my part that the SPX will challenge 1390 over the coming days/weeks. 

And to be honest, my inclination when that level (1390) is first approached will be to short the market, and probably aggressively.  But a lot can happen between now and then.

[James]

Can you give a little history of your experience with these techniques?  When did you start researching and developing your strategy, and when did you start implementing it?

[arebelspy]

I detected a reverse head and shoulders bottom in the SPX in early June...

Not, I hope, a verbal onslaught, but honest curiousity: how much time did you spend doing research, looking at charts, and so on in order to detect this?

It'd also be interesting to know how much time you spend on this on an ongoing basis, say hours per week, and what your return is, both as hourly wage and as ROI.

Jamesqf, the patterns become apparent almost immediately.  And I don't spend much time, a few hours a week analyzing charts, reading news, etc. since I'm hardly what you would call an active day trader. 

It seems to me, just on a theoretical level, that anything that becomes apparent that quickly is tough to make money on.

If you can see a pattern like that with very little time invested, shouldn't thousands of others be able to as well, or even tens of thousands or more?  Not to mention professionals who spend 20 times per week what you do?

And if they can't see those patterns, assuming they exist... how come you can?   And if they can see them, why wouldn't they all jump on the profit, and quickly eliminate the opportunity (thus giving us a great example of a soft efficient market)?

[smedleyb]

Arebelspy, I don't wish to imply that its that simple, like "oh, H&S bottom, time to coin money!"

The market is rarely that generous.

Again, bullish over 1330, as SPX works its way to 1390 (maybe a touch higher).  Minor resistance at 1350 (downtrend line) and again at 1365.  These are the zones I'm focusing on.

And trust me folks, I ain't trying to convert anyone, or profess to have all the answers.  Just giving you a glimpse into my mental universe.  I'll stay with and deal the criticism as we go.

[arebelspy]

I think you're missing the point of my question.  And I don't mean this as an attack, just genuinely curious why you think this isn't the case.

You say this:

Again, bullish over 1330, as SPX works its way to 1390 (maybe a touch higher).  Minor resistance at 1350 (downtrend line) and again at 1365.  These are the zones I'm focusing on.

If these are important zones, why can you pick up on that with only a few hours/week research, when those spending 20x that can't?  Or can they?  If so, why doesn't an efficient market quickly remove the opportunity?

[JohnGalt]

I think you're missing the point of my question.  And I don't mean this as an attack, just genuinely curious why you think this isn't the case.

You say this:

Again, bullish over 1330, as SPX works its way to 1390 (maybe a touch higher).  Minor resistance at 1350 (downtrend line) and again at 1365.  These are the zones I'm focusing on.

If these are important zones, why can you pick up on that with only a few hours/week research, when those spending 20x that can't?  Or can they?  If so, why doesn't an efficient market quickly remove the opportunity?

Arebelspy - I think he's saying that because so many people are looking for these same trends, their collective actions almost ensure that the trend will play out. 

But remember: there are so many technical based traders and trading programs that these chart formations, supports, and resistances, etc, become almost self-fulfilling prophesies.  They are actionable levels because so many people are acting on them.

I guess my question would then be - how do you get your trade in fast enough to once those tipping points are hit to take advantage?  Do you set your threshold to take place slightly before the standard so that you're in position ahead of time?

Also - does this maybe imply that these particular market inefficiencies are actually created because so many traders are looking for it?

[grantmeaname]

It's only a market inefficiency if it works. The fact that you've got a vocabulary that other people also use doesn't mean that technical analysis as a technique is effective, it means that other people believe that it's effective. If it doesn't consistently beat buy-and-hold investing after transaction costs, it doesn't work. It's never been demonstrated that technical analysis can do so.

[AJ]

If you can see a pattern like that with very little time invested, shouldn't thousands of others be able to as well, or even tens of thousands or more?  Not to mention professionals who spend 20 times per week what you do?

This discussion may be a bit over my head, so forgive me if this is naive, but...

The vast majority of the funds comprising the market are held by large entities (mutual and hedge funds) as opposed to individual investment accounts. Big guys can't move quickly, because they are buying and selling in such large quantities that their activity actually causes noticeable fluctuations in stock prices. Thus, they have to buy in slowly and sell off slowly. One doesn't need to know more than the big guys, one only needs to know what the big guy are doing and tag along. Even if thousands of other investors are doing the same thing, their holdings are so small comparatively that it doesn't matter. Only the movement of the big guys matters, so if you can recognize what they are doing, you can do the same thing but faster.

[arebelspy]

If you can see a pattern like that with very little time invested, shouldn't thousands of others be able to as well, or even tens of thousands or more?  Not to mention professionals who spend 20 times per week what you do?

This discussion may be a bit over my head, so forgive me if this is naive, but...

The vast majority of the funds comprising the market are held by large entities (mutual and hedge funds) as opposed to individual investment accounts. Big guys can't move quickly, because they are buying and selling in such large quantities that their activity actually causes noticeable fluctuations in stock prices. Thus, they have to buy in slowly and sell off slowly. One doesn't need to know more than the big guys, one only needs to know what the big guy are doing and tag along. Even if thousands of other investors are doing the same thing, their holdings are so small comparatively that it doesn't matter. Only the movement of the big guys matters, so if you can recognize what they are doing, you can do the same thing but faster.

That's a misconception.

I'm pretty sure since 84% of trading is high frequency trading (http://www.infowars.com/84-of-all-stock-trades-are-by-high-frequency-computers-only-16-by-humans/ - up from 60% in 2011: http://topics.nytimes.com/topics/reference/timestopics/subjects/h/high_frequency_algorithmic_trading/index.html) ... current trading moves fast enough to take advantage of and likely eliminate any of that possibility. 

[AJ]

That's a misconception.

I'm pretty sure since 84% of trading is high frequency trading (http://www.infowars.com/84-of-all-stock-trades-are-by-high-frequency-computers-only-16-by-humans/ - up from 60% in 2011: http://topics.nytimes.com/topics/reference/timestopics/subjects/h/high_frequency_algorithmic_trading/index.html) ... current trading moves fast enough to take advantage of and likely eliminate any of that possibility.

That's 84% of the trades, not 84% of the capital. If a manager wants to get into a large position, they still can't go all in in one fell swoop. HFT can take advantage of very small changes in price, getting in and out very very quickly, but that isn't exactly what I was referring to. It can takes days or weeks for a fund to get into a position without significantly affecting the price. That activity can be tracked and exploited.

Also, mutual fund managers are limited in what they are allowed to buy. Even if they could see disaster on the horizon, the best they can hope for is to lose less than their peers, they can't go all cash and wait for better buying opportunities.

Its just overly simplistic to say that since fund managers do what they do full time they must have every advantage over individuals. They have most of the advantages, but their size has its own limitations, both innate and regulatorily imposed.

[Mr Mark]

As a bogglehead, for want of a label, I love the day/ active traders. Without that churn I couldn't get away with low cost index  and mutuals. Go for it.

:-)

[arebelspy]

That's 84% of the trades, not 84% of the capital.

...okay?  With all those constant trades going on, why does it matter if a hedge fund manager moves slowly over a week or two - those HFTs constantly going on will eliminate gaps more or less instantaneously as he does so.

[Jamesqf]

Jamesqf, the patterns become apparent almost immediately.

That is really what I would worry about, because the human brain is such an efficient pattern detector that it will detect patterns even when there is no pattern to detect.  So perhaps you "reverse head and shoulders bottom" is indeed "very like a whale" :-)

Perhaps it's just down to temprament, but I would rather put my money in long-term investments: companies that have good P/E ratios, decent dividends, etc.  To free myself from the labor of finding such companies myself, I pick mutual funds that follow such policies. 

[smedleyb]

As a bogglehead, for want of a label, I love the day/ active traders. Without that churn I couldn't get away with low cost index  and mutuals. Go for it.

:-)

Glad to be of service! lol!

[smedleyb]

That's 84% of the trades, not 84% of the capital. If a manager wants to get into a large position, they still can't go all in in one fell swoop. HFT can take advantage of very small changes in price, getting in and out very very quickly, but that isn't exactly what I was referring to. It can takes days or weeks for a fund to get into a position without significantly affecting the price. That activity can be tracked and exploited.

Also, mutual fund managers are limited in what they are allowed to buy. Even if they could see disaster on the horizon, the best they can hope for is to lose less than their peers, they can't go all cash and wait for better buying opportunities.

Its just overly simplistic to say that since fund managers do what they do full time they must have every advantage over individuals. They have most of the advantages, but their size has its own limitations, both innate and regulatorily imposed.

Solid post, AJ.  I think one of the strengths of technical analysis is the way in which in filters out a lot of the day to day price noise in order to allow investors/speculators an opportunity to detect patterns of accumulation or distribution by the big funds. 

[smedleyb]

I guess my question would then be - how do you get your trade in fast enough to once those tipping points are hit to take advantage?  Do you set your threshold to take place slightly before the standard so that you're in position ahead of time?

Also - does this maybe imply that these particular market inefficiencies are actually created because so many traders are looking for it?

I use these levels as zones and try to layer into the trades;  say I think 1390 is the top of a move, I'll short a piece at 1385, maybe another at 1395.  There's no hard and fast rule.  Usually the market gives you a small window through which to execute the trade.  I'm a nobody trading peanuts so it's not like what I do even registers in the universe of stocks.

As to your second point, I think we're looking at a classic chicken/egg scenario -- do levels work and trader follow them, or do traders all look at the same level which causes them to work?  I've given up trying to figure out which comes first.

[Mr Mark]

Arebelspy,

Over the short term, there's an equal no. of buyers and sellers at a price. There can be big winners and losers, and you could say parts of Wall st act as the dealer in the middle, and take a cut.

Active trading can make you a lot of money if you guess right. The problem is no one can do it sustainably long term, and the competition is fierce. Fees will eat away at returns.

Long term, at best, its a suboptimal trading strategy. And most people loose money on it even in the short term.

[smedleyb]

I think you're missing the point of my question.  And I don't mean this as an attack, just genuinely curious why you think this isn't the case.

You say this:

Again, bullish over 1330, as SPX works its way to 1390 (maybe a touch higher).  Minor resistance at 1350 (downtrend line) and again at 1365.  These are the zones I'm focusing on.

If these are important zones, why can you pick up on that with only a few hours/week research, when those spending 20x that can't?  Or can they?  If so, why doesn't an efficient market quickly remove the opportunity?

Okay -- it's more than a few hours a week.  I was up til 2 AM last night studying my charts; I was up a 7 (before work) scanning headlines, preparing my game plan, attempting to locate opportunities; it's really a second job, truth be told. 

And yes, the greatest traders in the world know these zones/trends/patterns.  How quickly the opportunity is removed varies, but I've found the most glorious trade set ups allow you plenty of time to get on board.

[smedleyb]

Arebelspy,

Over the short term, there's an equal no. of buyers and sellers at a price. There can be big winners and losers, and you could say parts of Wall st act as the dealer in the middle, and take a cut.

Active trading can make you a lot of money if you guess right. The problem is no one can do it sustainably long term, and the competition is fierce. Fees will eat away at returns.

Long term, at best, its a suboptimal trading strategy. And most people loose money on it even in the short term.

Mr. Mark, I think you know exactly what you're doing when it comes to your investment style.  And you're right, commissions and "slippage" eat away at the scant profits most traders make.  The average life a trader is pretty short.  Most lose.

Truth be told I'm not really a trader.  I can go weeks without feeling the need to do anything.  The majority of my long term funds are in cash, and will be deployed "long-term" when the next phase of the global financial crisis plays out.  And we will know when that phase is in play when the very thought of buying a stock seems utterly foolish, dumb, and a recipe for insolvency.

In short, the time to buy is when fear, uncertainty, and chaos rule the day -- in the press, at the office, during casual conversation with friends, etc.

I think we're 60-70% through what I perceive to be a primary bear market which started in 2000 and continues to this day (punctuated by cyclical bulls, like 2003-2007, 2009-present).   There is no doubt in my mind that someday soon I'll be 100% long with little desire to make surgical moves in the market.  My style today is a product of my desire to protect the vast majority of my capital for the day our economy begins to experience a legitimate economic expansion, one based on investment via savings, not consumption via debt expansion. 

[JohnGalt]

I think you're missing the point of my question.  And I don't mean this as an attack, just genuinely curious why you think this isn't the case.

You say this:

Again, bullish over 1330, as SPX works its way to 1390 (maybe a touch higher).  Minor resistance at 1350 (downtrend line) and again at 1365.  These are the zones I'm focusing on.

If these are important zones, why can you pick up on that with only a few hours/week research, when those spending 20x that can't?  Or can they?  If so, why doesn't an efficient market quickly remove the opportunity?

Okay -- it's more than a few hours a week.  I was up til 2 AM last night studying my charts; I was up a 7 (before work) scanning headlines, preparing my game plan, attempting to locate opportunities; it's really a second job, truth be told. 

And yes, the greatest traders in the world know these zones/trends/patterns.  How quickly the opportunity is removed varies, but I've found the most glorious trade set ups allow you plenty of time to get on board.

This brings back up the question... is it worth it?  Which, of course, is primarily dependent upon three variables (as I see it).

Total amount you're trading with (using these methods):  P
Expected increase in yeild over more passive approaches:  r
Increase in time spent analyzing/trading over more passive approaches:  t

Your reward / time function then becomes   P*r/t

Using that and assuming 1,000 additional hours per year (part time job equivalent) for time here are the hourly rates recieved for every 1% increase in performance for different levels of P. 

$100,000 = $1/hour/1%
$250,000 = $2.5/hour/1%
$500,000 = $5/hour/1%
$1,000,000 = $10/hour/1%

Obviously if you spend less time these numbers change but even at 500 hours per year a 2% gain and a $500K portfolio, I'd be at $20/hr.
The opportunity cost will be different for everyone, but even that ( in my opinion top end) situation would probably not be worth it to me personally.  Especially given that the % gain is not guaranteed.  I can pick up part time consulting gigs for much better hourly rates than what I would gain spending a ton of time trying to gain a % or two on my current portfolio (for sure) and probably my FI portfolio as well.

I guess if you enjoy the analysis - maybe that should be factored in as a non monetary benefit too that would make it worth it.  I happen to very much not enjoy that side of things - even though (or maybe because?) I do statistics/modeling/forecasting for a living.

[smedleyb]

My business is my job; markets are my passion.

The fact that I'm getting paid anything at all is just gravy.

[JohnGalt]

I suppose that would do it.

I make a terrible hourly rate playing poker - but really enjoy it so I keep at it anyways.

To each their own...

[arebelspy]

Okay, so now that we've established:
Most people will lose money, and can't outperform the market.
If you theoretically could, it would take hours and hours, and your hourly rate is crap. (Thanks WhoIs for the analysis.)

So basically almost no one should do it, except for fun, and they should expect to lose money.

Mustachianism offers a way to maximize your time, rather than having to trade your time for stuff you don't want to do.  Seems to me that index funds are much more Mustachian under that umbrella.

The very, very, very rare exception aside.

[Jamesqf]

My business is my job; markets are my passion.

The fact that I'm getting paid anything at all is just gravy.

Exactly my point!  This is your hobby: even if you lose some money in the long run, you've had your enjoyment from it.  But for me, and I think for most people, it is not enjoyable, so it's worth paying someone a small percentage to do the work for us, and probably better than we could ourselves.

It's the same as when I do my own car repairs,remodelling, etc.  I may save money, or I might be better off financially if I paid someone and spent the time doing more programming, but the money isn't really the point.  It's the enjoyment I derive from doing the work that's my primary reward.

[smedleyb]

Okay, so now that we've established:
Most people will lose money, and can't outperform the market.
If you theoretically could, it would take hours and hours, and your hourly rate is crap. (Thanks WhoIs for the analysis.)

So basically almost no one should do it, except for fun, and they should expect to lose money.

Mustachianism offers a way to maximize your time, rather than having to trade your time for stuff you don't want to do.  Seems to me that index funds are much more Mustachian under that umbrella.

The very, very, very rare exception aside.

I agree with much of this.

My own personal goal is simply to get rich by buying market sell-offs (declines of 20% or greater) over then next 5 years and begin accumulating for the next great bull market that will commence when we pay off our debts, save a little, and invest for the future.  This country hasn't deleveraged by any means, unless one considers transferring private debt onto our public institutions a credible payment plan.  Until then, I'm more than comfortable attempting to be more tactical with my money (i.e., trade more) while maintaining high levels of cash.

I believe that this is the appropriate strategy to employ in a secular bear market, which my technical and historical analysis of the market says we are in. 



 

[smedleyb]

I suppose that would do it.

I make a terrible hourly rate playing poker - but really enjoy it so I keep at it anyways.

To each their own...

I think Poker and trading are very similar.  Unfortunately, in a bear market, all hold and no fold is a bad strategy.

 

[rjack]

Wow! This is a long thread, but I feel a need to throw in my opinions in an effort to summarize.

Efficient Markets - The stock market is inefficient in the short run (months) and efficient in the long run (years).

There are two types of investors: passive and active. Passive investors generally invest in ETFs or Mutual Funds and don't particularly like investing as an activity.

Active investors like investing as an activity. There are two types of active investors: Technical and Fundamental. Technical investors approach investing by looking at market supply/demand and predicting the direction of a stock/market. Fundamental investors look at the company behind the stock and try to predict future profitability and price.

All of these approaches are legitimate and you have to use what works best for your personality, knowledge, and interest.

[smedleyb]

Active investors like investing as an activity. There are two types of active investors: Technical and Fundamental. Technical investors approach investing by looking at market supply/demand and predicting the direction of a stock/market. Fundamental investors look at the company behind the stock and try to predict future profitability and price.

Is it possible to look at both?  I mean, do a fundamental analysis to determine the right company to buy; do a technical analysis to determine the right time to buy?

Personally, I like to buy when both the fundamentals and technicals are in sync. 

[arebelspy]

All of these approaches are legitimate

Maybe.  Some of us would argue that history and studies have shown the constant success of one of these, and the inability for almost anyone to succeed with the other.

The stock market is inefficient in the short run (months) and efficient in the long run (years).

Yes, but since most of us would claim we can't know what it will do in the short run, then trying to exploit those inefficiencies is akin to gambling.  Thus we go for the long run where we are reasonably confident we can make money and historically have done so.

Again, there may be a rare few that are the exception to this, and doing so is not impossible.  But for the average investor, it's extremely improbable and likely the path to losing money (or, at best, making some, but still underperforming what index funds would).

[rjack]

Active investors like investing as an activity. There are two types of active investors: Technical and Fundamental. Technical investors approach investing by looking at market supply/demand and predicting the direction of a stock/market. Fundamental investors look at the company behind the stock and try to predict future profitability and price.

Is it possible to look at both?  I mean, do a fundamental analysis to determine the right company to buy; do a technical analysis to determine the right time to buy?

Sure! I do a combination of index investing and fundamental investing in individual stocks.

All of these approaches are legitimate

Maybe.  Some of us would argue that history and studies have shown the constant success of one of these, and the inability for almost anyone to succeed with the other.

However, there are two main problems with studies on investing:

1) Past behavior does not guarantee future behavior. For instance, I do some index investing, but I'm also part of the massive baby boomer generation. What happens when boomers start selling off investments to fund retirement? Mr. ERE made this same argument because index funds make no or very little distinction about the quality of the stocks they hold. Mr. ERE also argued that the world of the future (energy/oil crisis, pollution, globalization) is fundamentally different from the past.

2) There are always outliers of any type of investing. Are these people lucky or skillful? Who can say? Is Buffet lucky or skillful? Are successful hedge fund managers with a long track record lucky or skillful?

[arebelspy]

1) Past behavior does not guarantee future behavior. For instance, I do some index investing, but I'm also part of the massive baby boomer generation. What happens when boomers start selling off investments to fund retirement? Mr. ERE made this same argument because index funds make no or very little distinction about the quality of the stocks they hold. Mr. ERE also argued that the world of the future (energy/oil crisis, pollution, globalization) is fundamentally different from the past.

Sure, but are you going to pick the strategy that has a track record that has lost lots of people lots of money and rarely, if ever, worked for anyone?  Or are you going to pick the one that has worked quite well in the past?

The future may be fundamentally different (everyone is always claiming "it's different this time!" and it has yet to be), it may not, but why would you assume something that hasn't worked in the past is the best strategy going forward?

2) There are always outliers of any type of investing. Are these people lucky or skillful? Who can say? Is Buffet lucky or skillful? Are successful hedge fund managers with a long track record lucky or skillful?

Does it matter?  If it doesn't work for almost anyone except for a very few outliers, we can debate if they're lucky or skillful, but isn't it enough to know that it's very unlikely to work for you?  That you almost certainly won't be lucky or skillful enough to beat the market, since almost no one is?

[rjack]

2) There are always outliers of any type of investing. Are these people lucky or skillful? Who can say? Is Buffet lucky or skillful? Are successful hedge fund managers with a long track record lucky or skillful?

Does it matter?  If it doesn't work for almost anyone except for a very few outliers, we can debate if they're lucky or skillful, but isn't it enough to know that it's very unlikely to work for you?  That you almost certainly won't be lucky or skillful enough to beat the market, since almost no one is?

Because if people like Buffet are skillful doesn't it make sense to invest with them even if they don't run index funds?

[smedleyb]

Day trading is a losing proposition for most people.

If you need to invest during a bear market, value and dividend funds are the way to go.

During a bull market, buy the best managed growth companies and just sit on your hands. 

[Jamesqf]

...the next great bull market that will commence when we pay off our debts, save a little, and invest for the future.

When?  I suspect IF would be the more appropriate word here.

[smedleyb]

...the next great bull market that will commence when we pay off our debts, save a little, and invest for the future.

When?  I suspect IF would be the more appropriate word here.

Massive skepticism regarding the potential for another bull market is a necessary condition for the next bull market.

As far as when:

http://www.ritholtz.com/blog/2012/06/picture-guide-to-financial-markets-since-1800/

As you can see, the history of the stock market the past 100 years shows multiple bear phases lasting anywhere from 16-21 years.  We are roughly 12-13 years into the current bear, thus one can imagine 4-5 more years of sideways to downward movement before the next bull rises from the ashes.

   

[Jamesqf]

...the next great bull market that will commence when we pay off our debts, save a little, and invest for the future.

When?  I suspect IF would be the more appropriate word here.

Massive skepticism regarding the potential for another bull market is a necessary condition for the next bull market.

You misunderstand.  I've no doubt there will be bull markets in the future.  What I don't expect to see is for the US (either the government or a great majority of individuals) to pay off our debts, save a little, and invest for the future.  If you're waiting for that to happen before investing, I expect you may pass away at an advanced age with a large pile of cash under your (perhaps figurative) matress.

[smedleyb]

You misunderstand.  I've no doubt there will be bull markets in the future.  What I don't expect to see is for the US (either the government or a great majority of individuals) to pay off our debts, save a little, and invest for the future.  If you're waiting for that to happen before investing, I expect you may pass away at an advanced age with a large pile of cash under your (perhaps figurative) matress.

Fair enough! lol.

[grantmeaname]

The same handful of totally unsubstantial statements keeps getting repeated here over and over again as if saying them enough will make it true. I stated at the beginning of the thread that the efficient market hypothesis means that consistently winning mutual fund managers can't exist. Maybe you disagree with that, but you can't totally ignore my argument, not refute the EMH, and then start talking about consistently winning mutual fund managers because it's been 20 posts since I last reminded you of that. If you won't counter my assertion that they can't exist, counter my assertion that they don't exist. Show me an actively managed mutual fund that outperforms an index fund with comparable risk characteristics after the expense ratio, and which has consistently done so over its history.

Baby boomers have about $40k of equities each according to my back-of-the-envelope estimate. There are 76M boomers across 20 years, so you've got 3.5M boomers retiring a year with $140B of stock. Let me underline this. If every boomer that retired sold every single penny of their stocks on the day they retired, the market would take a hit of $140B in the average year. How significant is that? It's 1.16% of the NYSE, which had a market cap of $12T in May.

Index funds rebalance when companies drop off their benchmarks, which should be an insignificant penalty compared to their large total AUM (I'd chase that link further and get something more substantial, but I'm getting 404 errors left and right).

[smedleyb]

The same handful of totally unsubstantial statements keeps getting repeated here over and over again as if saying them enough will make it true. I stated at the beginning of the thread that the efficient market hypothesis means that consistently winning mutual fund managers can't exist. Maybe you disagree with that, but you can't totally ignore my argument, not refute the EMH, and then start talking about consistently winning mutual fund managers because it's been 20 posts since I last reminded you of that. If you won't counter my assertion that they can't exist, counter my assertion that they don't exist. Show me an actively managed mutual fund that outperforms an index fund with comparable risk characteristics after the expense ratio, and which has consistently done so over its history.

Baby boomers have about $40k of equities each according to my back-of-the-envelope estimate. There are 76M boomers across 20 years, so you've got 3.5M boomers retiring a year with $140B of stock. Let me underline this. If every boomer that retired sold every single penny of their stocks on the day they retired, the market would take a hit of $140B in the average year. How significant is that? It's 1.16% of the NYSE, which had a market cap of $12T in May.

Index funds rebalance when companies drop off their benchmarks, which should be an insignificant penalty compared to their large total AUM (I'd chase that link further and get something more substantial, but I'm getting 404 errors left and right).

Consistently winning traders do exist:  Paul Tudor Jones, George Soros, David Tepper, Marty Schwartz, Warren Buffet -- there's plenty more.

Perhaps we need to differentiate between what's possible, and what's probable.

Furthermore, you keep referencing a little hypothetical I made above --  "what if boomers cash out their 401K's aggressively?"  If you don't see a correlation between the great bull marekt of 1982-2000 (yes, I know, my highly subjective delineations of market epochs) and boomer 401K inflows -- I do -- then you might not see the reverse, or 401K outflows to support them in retirement.  That' fine too.  I'll continue to view the boomer retirement phenomenon (not contributing to 401Ks, rather pulling money out) as a major head-wind facing the stock markets going forward, and you can continue to view them as inisgnificant (hey, it's just 1% of DJIA total cap!).

[sol]

If you don't see a correlation between the great bull marekt of 1982-2000 (yes, I know, my highly subjective delineations of market epochs) and boomer 401K inflows -- I do -- then you might not see the reverse

I would attribute that boom more to the creation of 401k plans in the early 80s than to the influx of boomer contributions.  Yes, a lot of boomers put money in the market, because it was made more advantageous for them to do so. 

And I think the creation of the public internet and subsequent tech bubble might have contributed a bit, too.

Personally, I know an awful lot of retiring boomers and as of now they are mostly planning to stay heavy in stocks until the absolute last possible moment.  The market is down and they're looking to ride the recovery (that you don't see) or even pass on those balances to their kids.  It's purely anecdotal, I realize, but I don't see boomers fleeing the market anytime soon.

[smedleyb]

"Major head-wind" does not entail "fleeing."

Boomers fed the bull for 20 years; going forward, they'll be more of a drag on the market.

Again, it was a marginal statement, a kind of hypothetical I posited to make another point; even so, I didn't think the crux of my statement was that controversial or so incorrect.  I still don't.

[Jamesqf]

I would attribute that boom more to the creation of 401k plans in the early 80s than to the influx of boomer contributions.  Yes, a lot of boomers put money in the market, because it was made more advantageous for them to do so. 

I may be wrong, but wasn't a lot of the money going into 401K plans money that would otherwise have gone into company pension funds?  Since those pension funds were investing in stocks &c anyway, the major difference was that the stocks were now held in portable 401Ks.

So I would expect not too great an effect from boomers selling parts of their 401K holdings, as they'll be purchased by younger people for their 401K plans.

[grantmeaname]

Consistently winning traders do exist:  Paul Tudor Jones, George Soros, David Tepper, Marty Schwartz, Warren Buffet -- there's plenty more.

That's right, good point! And their actively managed mutual funds do so well! Just type "MUTF:George Soros" into Google Finance and you'll see his incredible market-beating consistency. No, wait a minute, you specifically avoided my challenge by not naming a single actively managed mutual fund that outperforms an index fund with similar risk characteristics after expenses are factored in. Turns out George Soros isn't a mutual fund at all. Who knew?

Furthermore, you keep referencing a little hypothetical I made above --  "what if boomers cash out their 401K's aggressively?"  If you don't see a correlation between the great bull marekt of 1982-2000 (yes, I know, my highly subjective delineations of market epochs) and boomer 401K inflows -- I do -- then you might not see the reverse, or 401K outflows to support them in retirement. That' fine too.  I'll continue to view the boomer retirement phenomenon (not contributing to 401Ks, rather pulling money out) as a major head-wind facing the stock markets going forward, and you can continue to view them as inisgnificant (hey, it's just 1% of DJIA total cap!).

I wasn't referring to you, because you haven't mentioned it since much higher up. Rjack was making the same assertion despite the fact that neither of you has challenged my argument that it's mathematically irrelevant. Yes, I see the correlation, but correlation does not imply causation. Moreover, for the increase to have been caused by boomer buy-in, you'd have to show that the 401k bump was significant even after the concomitant pension decline was subtracted out (as Jamesqf also noticed). Otherwise it's a completely specious argument. Also, it's a percent of the entire NYSE, not the companies listed on the Dow.

[smedleyb]

Consistently winning traders do exist:  Paul Tudor Jones, George Soros, David Tepper, Marty Schwartz, Warren Buffet -- there's plenty more.

That's right, good point! And their actively managed mutual funds do so well! Just type "MUTF:George Soros" into Google Finance and you'll see his incredible market-beating consistency. No, wait a minute, you specifically avoided my challenge by not naming a single actively managed mutual fund that outperforms an index fund with similar risk characteristics after expenses are factored in. Turns out George Soros isn't a mutual fund at all. Who knew?

The distinction between "active fund manager" and "hedge fund manager" is based on compensation, nothing more.  The fund managers who can beat the market ultimately run their own hedge funds.

Bill Miller at Legg Mason ran LMTVX and beat the market for 15 years straight up until 2005.