New traders start approaching the market as an object of scientific method. They think it is a black box that is given to us, like in a problem statement in high school. They absorb all the knowledge they can find about it, believe successful people and their models of efficient market and stock price somehow representing the value of the company. They probably learn to avoid scam, but they are sure that the truth is out there. That the market will be operating forever according to yet undiscovered laws. That if they see contradictions in different known results and theories, they should just ignore it. And such optimism pays off - they do find relations in the historic data and utilize them to trade in the future. If the market were a static black box, they would do just fine.
Yet there is one situation where looking at history and black box approach may lead you in trouble. Quite literally, imagine a trail of candies lying on the ground. The above strategy is like picking up the candy without questioning who left it there. One may easily get into trouble at the end of the trail.
But once one starts asking questions like "who left the candy", it's really easy to stop trading and be overwhelmed by the complexity of what's inside the box. During meetings of our local investment club, I rarely say anything at all. Many other people jump into arguments, but to me none of their arguments are convincing at all. There is absolutely no reason to trust or believe into any principle that somebody tells you about the market.
So who left the candy? In fact, people like you did. Other traders who believed in similar things that you believe in made "mistakes", and you are getting their money now (assuming that you win). That is a simple picture. Once one starts to dig deeper, it is even more disturbing.
It will probably not be too far off to say that 90% of the money in the market is managed by people called "portfolio managers". That means this is their full-time job, they often have business and economy background and they are put in charge of large sums of money. It is generally not completely automated, it's more like a machine-human interface. Human still does the steering, and the machine takes care of the details.
Now these guys do not actually take money from you. You don't even have enough money to feed their greed. Most of their wins is money taken from each other. That is, even though these people have lengthy resumes with tons of accomplishment and expertise in the area, roughly 50% of them end up losing every year. Stock market does not "generate" money by itself. The only way for someone to win is for someone to lose.
It's ironic then that all of them were able to convince their rich employers that their portfolio management skills are above average. In fact, they are not even rational players. If one tries to use game theory to this problem, one sees that many of the portfolio managers never really tried to optimize their game strategy against other portfolio managers, like they should optimally. Instead, they have empirically collected a huge body of knowledge about how to do their job, that was based essentially on the first approach described above (black box) plus some evolutionary dynamics that made them slowly abandon the methods that do not play well against other players. They still probably have tons of methods used daily that make absolutely no sense from the point of view of game theory. And they will keep using them for a while.
The problem is how fanatic they are on this erroneous path. An ideal game theory strategy against them involves studying their thought process, however inappropriate for the problem, then modeling them by a few math equations and coming up with optimal strategy. But their thought process is so sophisticated (and probably not even deterministic) that it defies any simple modeling. In this way, even though they are not getting closer to the better 50% of their crowd (the winning one) by indulging in all those economy studies, they somehow protect themselves from bright people who would want to attack them with correct math tools. And as a bonus, they also manage to charm their rich employers with the obscure language of finance.
I find this field to be not in the realm of science, it more resembles alchemy, where you secretly develop outlandish recipes that do not actually work, and make colorful sparks to awe the king so he does not think of beheading you this time. Over the years, alchemists developed some kind of understanding of nature, but they also had tons of misconceptions that held them back.
Yet there is one situation where looking at history and black box approach may lead you in trouble. Quite literally, imagine a trail of candies lying on the ground. The above strategy is like picking up the candy without questioning who left it there. One may easily get into trouble at the end of the trail.
But once one starts asking questions like "who left the candy", it's really easy to stop trading and be overwhelmed by the complexity of what's inside the box. During meetings of our local investment club, I rarely say anything at all. Many other people jump into arguments, but to me none of their arguments are convincing at all. There is absolutely no reason to trust or believe into any principle that somebody tells you about the market.
So who left the candy? In fact, people like you did. Other traders who believed in similar things that you believe in made "mistakes", and you are getting their money now (assuming that you win). That is a simple picture. Once one starts to dig deeper, it is even more disturbing.
It will probably not be too far off to say that 90% of the money in the market is managed by people called "portfolio managers". That means this is their full-time job, they often have business and economy background and they are put in charge of large sums of money. It is generally not completely automated, it's more like a machine-human interface. Human still does the steering, and the machine takes care of the details.
Now these guys do not actually take money from you. You don't even have enough money to feed their greed. Most of their wins is money taken from each other. That is, even though these people have lengthy resumes with tons of accomplishment and expertise in the area, roughly 50% of them end up losing every year. Stock market does not "generate" money by itself. The only way for someone to win is for someone to lose.
It's ironic then that all of them were able to convince their rich employers that their portfolio management skills are above average. In fact, they are not even rational players. If one tries to use game theory to this problem, one sees that many of the portfolio managers never really tried to optimize their game strategy against other portfolio managers, like they should optimally. Instead, they have empirically collected a huge body of knowledge about how to do their job, that was based essentially on the first approach described above (black box) plus some evolutionary dynamics that made them slowly abandon the methods that do not play well against other players. They still probably have tons of methods used daily that make absolutely no sense from the point of view of game theory. And they will keep using them for a while.
The problem is how fanatic they are on this erroneous path. An ideal game theory strategy against them involves studying their thought process, however inappropriate for the problem, then modeling them by a few math equations and coming up with optimal strategy. But their thought process is so sophisticated (and probably not even deterministic) that it defies any simple modeling. In this way, even though they are not getting closer to the better 50% of their crowd (the winning one) by indulging in all those economy studies, they somehow protect themselves from bright people who would want to attack them with correct math tools. And as a bonus, they also manage to charm their rich employers with the obscure language of finance.
I find this field to be not in the realm of science, it more resembles alchemy, where you secretly develop outlandish recipes that do not actually work, and make colorful sparks to awe the king so he does not think of beheading you this time. Over the years, alchemists developed some kind of understanding of nature, but they also had tons of misconceptions that held them back.
No comments:
Post a Comment