The Frontal Cortex

Does the 'go read a book' advice work for performance on GREs too? I hope so.

Posted by: Ted | August 10, 2007 11:49 AM

Actually, "go read a book" was exactly how I passed tests in college. I also didn't do more than brush up for my GRE's. Cramming and overstudying can leave you paranoid about your performance in an exam, while relaxing and taking your mind off the material can help you focus on what's important - the questions in front of you. Of course, that doesn't matter all that much if you don't know the material well to begin with.

Posted by: Brian Thompson | August 10, 2007 12:28 PM

I have one quibble with your investment strategy. Less information may result in better decisions in the short term, but for long-term investment strategies, the long view is clearly better than the short term.

Example- if you had bought Halliburton and Chevron stock when Cheney seized the presidency, you would have done very well over the last seven years. Perhaps you'd feel ethically tainted by your decision, but from a purely $$$$-motivated perspective, it would have been absolutely the smartest thing you could have done. Or, even better, if you had invested in a wide portfolio of narrowly-focused oil and oil-services, you could have mitigated the risk that any one company would be tainted by corruption scandals while ensuring that you could capitalize on the huge run-up in oil stocks.

As another example, if you are still holding stock in any company that is involved with home building or mortgage sales, you're an idiot. It's been blatantly obvious that Toll Bros. and HomeDepot have been headed for the rocks for the last 18 months. Every month, the news is the same- falling home prices, fewer new home starts, record lows for home sales, record highs for defaults on mortgages. All of this news points in one direction- of course, now it's too late to do anything about it, but if you had been paying attention in July of last year, you would have sold it all then and gotten out before the walls started coming down around you. Same goes for any company involved in lumber production or sales- if nobody is building houses, then nobody is buying lumber... inventories go up, profits go down, stock price goes in the tank. To make money on this trend, all you needed to do was pay attention to fed interest rates and the trends in the sub-prime mortgage market.

In a larger sense though, the point you make about overwhelming information and trading may be true- as a rule, daytraders lose money, because they trade on rumors. I would argue that the mistake is trading individual companies based on information about that specific company, rather than trading groups of companies within an industry (or market sectors) based on the easily-understandable long term trend for that sector.

A free prediction- medical device companies in the US have been going through the roof for the last 5 or 10 years. As more baby boomers get older, they're going to want more artificial knees and hips. It only makes sense that the companies producing knee and hip joints will have to grow to keep up with demand... easy money.

Unless someone like Edwards is elected and actually attempts to change the fundamental structure of paying for healthcare in this country, in which case anything could happen. But for the next three or four years, companies like Smith&Nephew and Zimmer are a pretty safe bet, as long as you diversify your risk between them so that no one company can drag you all the way down.

of course, none of this should be taken as actual investment advice. Investing carries risks, you could lose your shirt or your house, I am not a lawyer or an investment adviser, past performance is not an indicator of future earnings.

Posted by: tekel | August 10, 2007 1:30 PM

Buying and selling stocks based only price pattern information is called "technical analysis". There are many variations, and it is very common. It is condemned by many finance and economics academics, since if it's any better than indexing, it implies gross market inefficiencies (people selling or buying at the "wrong" price).

In recent years, though, some have come to think that there may be "technical" approaches that add some value by acting as a proxy for behavioral finance strategies.

However, Warren Buffet is a fundamentals investor, who does NOT use "technical" approaches (he is a famous opponent of them), and who does rely on actual real life knowledge of companies and economic conditions.

So why did Warren Buffet make so much money, while the students in the short term experiment did worse using actual information than by merely using what amounted to a simplistic version of technical analysis?

Of course, Warren Buffet could have been lucky, but I don't think so. First of all the study was very short term, and second of all, the students involved were presumably inexperienced. Warren Buffet made insightful and patient use of selected information over many years. Unfortunately it would be very difficult to duplicate his performance.

Also, there could have been biasing factors. For example, the students with less information might actually have done less, since they had little "guidance" on how to act. Frequent trading has been shown to be detrimental for most small investors (to a high degree).

I wonder if the original reference is easily avaialable...

Posted by: harold | August 10, 2007 5:00 PM