The MICCJournal Volume 3, Issue 2 Mutual Investment Club of Cornell Monthly Newsletter Apirl 3, 2011 1 A Random Walk Down The Human Mind By Ali Yazdi When Eugene Fama galvanized the Ef- cient Market movement in the 1960s his work went largely unchallenged until the 1990s, and the Efcient Mar- ket, a notion that suggests monkeys throwing darts at the Wall Street Jour- nal have just a good a shot as anyone else in outperforming the market, reigned supreme. During this time though, if you had been with Warren Buffett in 1964 when he bought Berk- shire Hathaway for $11.5 a share, you would, on December 13, 2007, have made $13,043 for each dollar invest - ed. Thus, unless we are to attribut e Buffett’s amazing returns to pure luck, we have to ask ourselves if the Ef- cient Market Hypothesis truly holds. So as is my duty as a member ofthe investment community, I will set out in the course of these next 400 words to try and suggest that MICC and Wall Street is not just a bunch of people wasting their time with the work of monkeys. In fact for you, the individual investor, I will try to illuminate some of the more interesting aspects of the market. The contrarian investor is a man who lives life on the edges. Th e Clint East- wood of investors, he buys when ev- eryone is screaming sell, and although I love Clint Eastwood, the numbers since January 3rd, 2000 suggest ifthe good old contrarian had bought whenever the S&P had been down over the past twenty days or sold ifthe S&P had been up, he would have been 1332 times correct to 1480 wrong. Of cour se, such numbers sug- gest the market is pretty random right? Well, here’s where it gets interest - ing. Let’s control for every time the market has been up 4% over the past twenty days. With these param- eters, the market goes down over the next twenty days at a count of 177 in comparison to a count of 294 forthe market to continue upwards. In this case, our poor Clint Eastwood contrarian investor would have been absolutely slaughtered as the mar- ket continuously churns upwards. So I could stop here, throw a few citations in, do some studies, adjust my vernacular to the “you will be asleep in two minutes” mode, and bam…Nobel Prize. I’m suggesting when the market has been up signi- cantly (in this case ~4%) the market wants to continue up. Follow the trend, right ? Y es, but denitely no. You see, when we take out those days when the market has been up 4% in the past twenty days, we see that 1186 times the market goes in the same direction and 1155 times it reverses directions. Almost a d ead heat. Now, let’s go deeper and see what happens when we only lookat the returns over the next twentydays, when over the past twenty days the market has dropped betwee n 7% and 18%. Magically all of a sudden the contrarian investor is a sheer ge- nius as the market reverses direction and goes up 121 times in comparison to 93 times it continues downwards. The returns come out to 0.39% in prot per trade, which is really next to nothing, but if you could guaran - tee yourself 0.39% in returns for the 214 trades where those criteria were met, you would be sitting with overa 100% gain compared with an 11% loss over that time period in the S&P Now calm yourself over there, be- cause the next argument is where the tr ue money lays. When we look at the 214 times when the market has been down between 7-18%, we see that the average move of the market over the next twenty days comes out to an outstandin g 6.73% move. If w e did a buttery option with wings be- ginning ±6 from the current price we would have made roughly 8000 dol - lars at roughly 40 dollars per trade. Thus, to sum it all up, the market loves following the trend and optimism when it’s climbing upwards, but when it goes down, it goes down fast, and it gets chaotic, but ultimately the con- tra rian wins in the end. So when you’ re investing in the market, go ahead and take a Clint Eastwood stand when the market is down 10%, but stay on the bandwagon when it is going up. Why is th is the case? Just take a ran- dom walk down to a MICC meeting. Total Up (>4%) Total w/ Col II Down (7-18%) Moves Same Direction 1480 294 1186 93 Reverses Direction 1332 177 1155 121 Contrarian Success Ratio 0.901 0.602 0.974 1.301
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