AWOL wrote:GoSeigen wrote:JohnW wrote:either you're not investing optimally or you think you know something the rest of the market doesn't know.
And a false dichotomy, and plain wrong in fact. The market does not price optimally, it prices based on the level the most stupid trader currently wishes to trade at. Why this is not blindingly obvious I have no idea. Very simple example: say I think a security is worth 104p. As a canny investor I am not going to go out there and pay 104p to buy it! There is someone willing to sell it to me at 16p. So I don't say to them, hey these are probably worth 104p, let's agree a price much closer to that because the market is efficient after all. I happily buy them at the offered 16p. Then the "market" says that I think they are worth 16p and the seller thinks they are worth 16p. NO! That is just the price we traded at. My real valuation of them was 104p but I bought them for 16p because someone was happy to sell at that price. The current trading price tells you nothing about the value of an investment and nothing about the market's valuation of an investment. It just tells you the price the dumbest person at the time is happy with.
I guarantee, the moment an investor figures this out properly for himself his investment performance will improve.
GS
The bid and ask prices are set by the market and the mid-price is commonly used as the markets valuation of an equity. How else does the market weighing machine express the value other than the current asking price and the current bid price.
Are you seriously suggesting that is the ONLY way possible? I know it is ubiquitous, I'm just trying to express that it is terribly crude and it's not in the least surprising to me that people get confused about values of investments as a result.
Once a trade is done of course it is the next remaining ask and bid price that set the price. It is the buying and selling that weighs the value as the market is made up of the participants ranked from most to least attractive price. The market value = share price x number of shares.
Again this is the accepted wisdom, but I don't agree. This to me is one mechanism by which traders are matched in securities markets, but to then say "The market value = share price x number of shares" is to too narrowly define "market value". Or too attach too much significance to this crude number.
I think the really interesting bit is... is the market efficient. In an absolute sense then it's clearly not (otherwise irrational effects like momentum wouldn't be possible as the price would immediately correct to include new information whereas momentum shows that stocks continue to gain value over extended periods of time). So that leads to the question to what degree is it efficient and to what degree to markets vary in efficiency. It can clearly be seen that the S&P500 is highly efficient although arbitrage is still possible to it's not 100%. Other markets such as the FTSE Small Cap are far from efficient.
I don't think momentum is at all irrational if you accept what I say above. It's a simple acceptance that the current marginal trades to not reflect the view of the market on the value of the security. If you believe, for example that dumb money is selling and that prices are thus somewhat below where the smart money believes they should be then it's perfectly rational to suppose that the price will rise over time. Further, it is perfectly rational to project that your return will be current yield + annual price growth. I think it is also rational to believe that because of inertia prices will overshoot the [smart money] true valuation and that the dumb money will switch to overpaying.
I am an engineer and anyone with a similar maths background will see the parallels with harmonic motion. Harmonic motion is difficult to understand but it is not irrational. Overshooting the equilibrium point (aka momentum) can be easily understood with a bit of Newton-era calculus.
So what to do... it turns out that most markets are efficient enough that their large cap markets are unlikely to be worth the risk of active fund management (although the FTSE100 may be an exception). There is a good case for active investment in small caps in theory although in practice this has worked best outside the US. Liquidity issues suggest that a closed ended vehicle would be best. Then there is the question of whether charges make the small over large premium investible...
Even if most markets most of the time are efficient enough, there is plenty of room for inefficiencies. If one is going to refuse to think of the value of one's investment and simply put faith in "the efficiency of the market" then you'd better
hope you are not investing in one of the periods or markets that is NOT being efficiently valued. This thought was behind my first ironic post on the current thread.
Personally I prefer not to hope but to use my skills and knowledge to the best of my ability.
GS