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Posted by Andrew Koenig on November 26, 2008, 10:18 am
A stray thought:
Usually when demand increases for something, that drives the price up, which
decreases the demand until the price stabilizes.
But this stabilizer seems to work in the wrong direction in financial
markets: When demand increases for a stock, that drives the price up, which
*increases* demand -- at least until it is obviously overpriced. When
demand decreases for a stock, that drives the price down, which *decreases*
demand, inducing more people to sell.
I've heard this notion expressed as follows: "Why is it that when Macy's
holds a sale, people rush to buy; but when Wall Street holds a sale, people
rush to sell?"
So if I'm right, investor behavior is a natural market destabilizer: Price
changes feed back into investor behavior, which tends to push prices in the
same direction in which they were already moving. More evidence for this
phenomenon is that when stock prices decline, there is invariably a huge
outflow from stock mutual funds to bond mutual funds.
In general, when a feedback loop causes instability, reducing the amount of
feedback will reduce the instability, often dramatically. When a PA system
starts to squeal, turning down the volume just a tiny bit will usually stop
it. Which suggests that one way to increase stability in financial markets
is to find a way to influence investor behavior in general -- and it
probably doesn't need to be very much of an influence.
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Posted by on November 26, 2008, 10:59 am
"Andrew Koenig" wrote:
> So if I'm right, investor behavior is a natural market destabilizer: Price
> changes feed back into investor behavior, which tends to push prices in the
> same direction in which they were already moving.
Lately I think about the decline often in terms of, "How much of it is
based in panic, and how much is based in at least a crude calculation
of declining company earnings?" To me much of the decline is panic-
based, driven by what you say above.
> In general, when a feedback loop causes instability, reducing the amount of
> feedback will reduce the instability, often dramatically. When a PA system
> starts to squeal, turning down the volume just a tiny bit will usually stop
> it. Which suggests that one way to increase stability in financial markets
> is to find a way to influence investor behavior in general -- and it
> probably doesn't need to be very much of an influence.
But ISTM that it has to be "influence" of such a quality that it has
to get to the masses of investors. Which to me means that, even if the
influence is simply a small change in investing philosophy, getting
enough of the masses to adopt this change is a tall task.
I see market panics as substantially psychological behavior. A
Darwinian model works. People are going to lose their shirts from time
to time. The more skilled will survive. It is the proverbial (for the
liberal arts crowd) shrinking sinusoidal curve of input-output (for
the techie crowd), such that society tends towards things getting
better overall, insofar as health and well-being are concerned.
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Posted by dumbstruck on November 26, 2008, 3:07 pm
On Nov 26, 5:59 am, honda.lion...@gmail.com wrote:
> I see market panics as substantially psychological behavior. A
Overshoot is proposed to be a rational process that is normally in the
self interest of participating investors in an article "Why do share
prices move relentlessly in one direction?" at
http://www.economist.com/finance/displaystory.cfm?story_id=12652255 .
They say "a new working paper by researchers at the London School of
Economics (LSE) suggests that the momentum effect is still consistent
with the idea that investors are rational.". In fact they find it
harder to explain the mechanisms of eventual "reversion to the mean"
3-5 years later than overshoot.
I normally enjoy the cycles of momentum, but not at the crazy speed
and extent such as recent tech, oil, and financial bubbles. Maybe
modern active investment tools are particularly supporting the
rationality that the paper describes.
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Posted by on November 26, 2008, 4:21 pm
> > I see market panics as substantially psychological behavior. A
>
> Overshoot is proposed to be a rational process that is normally in the
> self interest of participating investors in an article "Why do share
> prices move relentlessly in one direction?"
athttp://www.economist.com/finance/displaystory.cfm?story_id=12652255 .
> They say "a new working paper by researchers at the London School of
> Economics (LSE) suggests that the momentum effect is still consistent
> with the idea that investors are rational."
I think all the authors are suggesting is that almost any action can
be argued to be in one's self-interest.
The article (and I imagine the paper cited) are excellent
justifications for further dabbling in timing using momentum tactics.
I say dabbling, timing, and momentum approaches are all irrational
approaches to investing.
If one wants to sleep at night, one bets on economies, not short-term
fluctuations.
> I normally enjoy the cycles of momentum,
This enjoyment is like that taken from waiting for the next card in
blackjack. Gambling is this way. Investing is not.
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Posted by dumbstruck on November 26, 2008, 10:19 pm
On Nov 26, 11:21 am, honda.lion...@gmail.com wrote:
> > http://www.economist.com/finance/displaystory.cfm?story_id=12652255 .
> > They say "a new working paper by researchers at the London School of
> > Economics (LSE) suggests that the momentum effect is still consistent
> > with the idea that investors are rational."
>
> I think all the authors are suggesting is that almost any action can
> be argued to be in one's self-interest.
>
> The article (and I imagine the paper cited) are excellent
> justifications for further dabbling in timing using momentum tactics.
> I say dabbling, timing, and momentum approaches are all irrational
> approaches to investing.
No, that interpretation of me and the article is incorrect. You can
just click on the article citations for an executive summary or the
paper itself (from "The Paul Woolley Centre for the Study of Capital
Market Dysfunctionality" which certainly wouldn't be trying to
whitewash a bad practice). Summary at
http://www.lse.ac.uk/collections/paulWoolleyCentre/pdf/Non%20Technical%20Summary.pdf
They are explaining "investor beware", because there is good logic
behind the fine granularity moves that comprise a boom or bust. You
can choose to benefit by going either with or against this process (or
opt out), but this may be your chance to understand it rather than
fobbing it off as irrational psychology. As the authors said, it
springs from their frustration at being a value fund during the tech
bubble, and even after vindication of their value approach they came
to see the need and logic for momentum.
I AM NOT TALKING ABOUT OPPORTUNISTIC SHORT TERM MOVES, as you
repeatedly characterize my writeups. Momentum across years and years
can be a reasonable part of asset allocation, because at the heart of
it is a good fundamental story for some sector (eg. midcaps) or global
region that I can commit $ to for that fact alone, but then those
slower to recognize it pile on and on to accelerate returns. You may
miss the first third of the rise and absorb the first third of the
fall, but the middle third is easily in your pocket. This is how I
retired early and I don't see how any aware person can fail to use it
successfully as at least a bias in asset allocation.
For example how could a Fidelity investor possibly overlook
outperformance of their midcap Leveraged Company fund over 5 of the
last 6 years http://finance.yahoo.com/q/bc?s=FLVCX&t=my&l=on&z=m&q=l&c=^GSPC
In a slow, ladylike fashion it quadrupled while SP500 just gained
about half, and took over a growing part of my portfolio. Even the
downfall was slow enough to preserve significant gains by the same
momentum principles applied downward. Have done similar things with
various country funds, etc over long timeframes.
> If one wants to sleep at night, one bets on economies, not short-term
> fluctuations.
>
> > I normally enjoy the cycles of momentum,
>
> This enjoyment is like that taken from waiting for the next card in
> blackjack. Gambling is this way. Investing is not.
No gambling or short term stuff, with 2 exceptions. Must to be ready
to exit fast because crashes can be quick and lengthy. The Japanese
bubble and the tech bubble never really recovered afterwards for buy
and holders. And more recently I pointed out the NEW need for timing
your entrance to avoid losing years of expected returns in the insane
fluctuations of a few hours. A blind buy order can and has led to
grossly overpaying for a SP500 or 20/30yr tbill position if you don't
shield the timing such as with etf limit orders.
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